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Dear MARIA, We just published a new blog—please find the full text below.  How High Economic Uncertainty May Threaten Global Financial Stability (Credit: IMF Photo/Tuane Fernandes) By Mario Catalán, Andrea Deghi, and Mahvash S. Qureshi Uncertainty is not as easily measured as traditional indicators like growth or inflation, but economists have built some reliable proxies. One of the best-known gauges is the Economic Policy Uncertainty Index, which tallies how many news stories in major publications cite uncertainty, the economy, and policy. Others track the difference between published economic data and what economists previously projected. With measures like these still elevated after years of disruption from the pandemic, the surge in inflation, fraying geopolitics and war, climate disasters and rapidly evolving technologies, we now have a better understanding of how greater uncertainty can threaten financial stability. It can exacerbate risks of financial market turmoil, delay consumption and investment decisions by people and businesses, and prompt lenders to tighten the credit supply. One important observation is that uncertainty about the economy may not always be in step with uncertainty reflected in financial markets. As we show in a chapter of the Global Financial Stability Report, disconnects between high economic uncertainty and low financial market volatility can persist over time. But if a shock brings market volatility roaring back, it can have much broader implications for the economy.  If measures of economic uncertainty were to climb like they did during the global financial crisis, then what we consider as the lowest decile of potential outcomes for economic growth—otherwise known as downside tail risk—would drop by 1.2 percentage points. This means that if the global economy was projected to grow by 0.5 percent in an adverse scenario, it would now be expected to contract by 0.7 percent.  These economic impacts can vary across countries. These effects also can be amplified when public and private debt levels are elevated relative to the size of a given economy.  More generally, high economic uncertainty can amplify what we call the macro-financial stability tradeoff associated with loose financial conditions. When financial conditions become easier, expectations for economic growth typically go up and downside risks to the economy in the first year are reduced. That’s because of factors like lower interest rates, higher asset valuations, narrower credit spreads and reduced stock market volatility. But easy financial conditions can increase debt vulnerabilities, which worsen downside risks to economic growth down the road. Our analysis shows that a disconnect between the economy and the market increases the chances of a sudden jump in financial market volatility and a big drop in asset prices following an adverse shock.  The potential harms from economic uncertainty are important for policymakers to recognize also because they can have cross-border spillover effects through trade and financial linkages. These spillover effects have the potential to trigger international financial contagion. Policymakers should help provide more certainty by enhancing the credibility of their frameworks through, for example, adopting fiscal and monetary policy rules backed by strong institutions. In addition, greater transparency and well-designed policy communication frameworks can better guide market expectations—making policy decisions, and their transmission to the real economy, more predictable. As high uncertainty exacerbates the effects of debt vulnerabilities on the real economy, policymakers should proactively use adequate macroprudential policies to limit those risks. This is particularly relevant when financial conditions are loose and appear disconnected from elevated uncertainty about the broader economy. In addition, fiscal policies should prioritize sustainability to keep elevated public debt levels from raising borrowing costs that in turn risk undermining macro-financial stability. —This blog is based on Chapter 2 of the October 2024 Global Financial Stability Report, “Macrofinancial Stability Amid High Global Economic Uncertainty.” Support for Economic Reforms Hinges on Communication, Engagement, and Trust (Credit: IMF Photo/rogeranis.photo) By Silvia Albrizio, Bertrand Gruss, and Yu Shi The global economy is stuck in a low-growth gear, largely because of aging populations, weak business investment, and structural frictions that prevent capital and labor from flowing to where it can be most productive. As demographic pressures intensify and the green and digital transitions call for significant investment and resource reallocation across companies and industries, some countries are poised to fall further behind. This makes it even more urgent to update the rules that shape how economies operate. Although specific policy priorities differ across countries, many economies share the need to ease market entry for new businesses, foster competition in the provision of goods and services, encourage workers to stay in the labor force, and better integrate immigrant workers. Reforms like these need broad societal support, yet public discontent has mounted since the global financial crisis. To build trust and public support, policymakers need to improve communication, engage the public when designing reforms, and recognize some people may need support if reforms hurt them, as we show in new analysis highlighted in a chapter of the latest World Economic Outlook. Understanding social resistance Our exploration of factors that shape public attitudes toward reforms shows that resistance often extends beyond mere economic self-interest. Personal beliefs, perceptions and other behavioral factors account for about 80 percent of support for reforms, according to our surveys of more than 12,000 people across six representative countries. Crucially, knowledge and misperceptions about the need for reform and the effects of policies are the primary predictors of differences in policy support. This is important—and encouraging—because it offers a clear area for policymakers to act. Perceptions of distribution and fairness are also critical. Reform opponents often worry more about the impact on their communities, particularly the most vulnerable, than on themselves. For example, opponents fear reforms to increase the role of the private sector in the electricity and telecommunications industries would make those services less affordable and reduce access for the poorest. Lack of trust can also fuel opposition to reforms. People who say they oppose reforms, even if their concerns were to be adequately addressed by additional measures, mostly cite general distrust of the parties involved and doubts about the government’s ability to implement policy changes and mitigate any harms.   Strategies and tools to boost support Our analysis suggests a multi-faceted strategy can ease resistance to structural reforms: Information: Effective communication is at the core of a successful reform strategy. This goes beyond advertising the reforms. Policymakers must convincingly explain the need for change, the expected effects, and how they might be achieved. Providing clear and nonpartisan information that corrects misperceptions significantly increases public support, we find. For instance, it led to more than 40 percent of those who were opposed to migrant integration policies in our survey to change their mind. Engagement: Dialogue between officials and the public should be two-way. Allowing people to help shape policies and voice concerns fosters a sense of community ownership over reforms, making individuals more likely to support proposed changes. Mitigation: Acknowledging that reforms may hurt some groups and addressing those concerns with tailored mitigating measures is essential to gaining public support. And it should be grounded in the previous pillars. Mitigations like temporary cash support or training programs should be informed by two-way dialogues between officials and citizens. Trust: The critical pillar on which all three above rely upon is trust. Effective communication requires confidence in both the message and the messenger. To build trust in the process, the engagement with citizens needs to start early, in the policy design stage. And reform design mechanisms should reassure the public that the government will deliver on mitigating commitments when reforms are done. Establishing credible and independent government bodies to conduct and validate policy analysis can be particularly helpful. First-generation reforms to address corruption and improve governance are fundamental to restoring faith in institutions. Policymakers need to enhance their toolkit to build on this strategy and make reforms more acceptable to people. Public forums, pilot programs, and opinion surveys can help inform a two-way dialogue with citizens. Large-scale surveys, focus groups, and other participatory tools can identify concerns, craft adequate mitigations, and build consensus for reforms. New civic technologies, such as digital community engagement platforms, should also help more citizens participate. Effective reform design requires thorough consultation, communication, and mitigation to compensate those who might be hurt. Better tools to encourage participation will help people better understand proposals and build the public trust needed to carry out vital economic reforms. These principles should also be reflected in the IMF’s periodic reviews of its program, surveillance, and capacity development initiatives.  —This blog is based on Chapter 3 of the October 2024 World Economic Outlook, “Understanding the Social Acceptability of Structural Reforms.” Global Inflationary Episode Offers Lessons for Monetary Policy (Credit: iStock by Getty Images/winhose) By Jorge Alvarez, Alberto Musso, Jean-Marc Natal, and Sebastian Wende The inflation surge over the past three years followed a unique disruption to the global economy. Pandemic lockdowns initially tilted demand away from services and toward goods. But this came at a time when unprecedented fiscal and monetary stimulus boosted demand, and many firms were not able to ramp up production fast enough, resulting in mismatches between supply and demand and rising prices in some sectors. For example, ports were stretched to or beyond their capacity, partly due to pandemic-related staffing shortages, so as demand for goods surged, this resulted in backorders. When economies reopened, demand for services came roaring back and Russia’s invasion of Ukraine sent commodity prices soaring, in turn pushing global inflation to its highest level since the 1970s. Our chapter of the latest World Economic Outlook reflects on this episode, drawing lessons—both new and old—for monetary policy. To understand the recent global inflation surge, we need to delve beyond traditional macroeconomic aggregates. Our modeling shows how inflation spikes in specific sectors became embedded in core inflation, a less volatile measure that excludes food and energy. Key to our analysis is the interaction between soaring demand and sector-specific bottlenecks and shocks. These caused large shifts in relative prices that resulted in an unusual dispersion of prices. When supply bottlenecks became widespread and interacted with strong demand, the Phillips curve—the main gauge of the relationship between inflation and economic slack—steepened and shifted upwards. The steeper Phillips curve implied that relatively small changes in economic slack could have large effect on inflation. That came with bad news and good news. The bad: inflation surged as many sectors hit capacity constraints. The good: it was possible to curb inflation at a lower cost in terms of lost economic output. This last insight leads us to the new lesson: widespread supply bottlenecks can present central banks with a favorable tradeoff when confronting a demand surge. Because the Philips curve becomes steeper in such cases, policy tightening can be particularly effective at rapidly bringing down inflation with limited output costs. However, when bottlenecks are confined to specific sectors with relatively flexible prices, such as commodities, we are reminded of an old lesson: the common practice of focusing monetary policy on core inflation measures remains appropriate. Excessive policy tightening in such cases can be counterproductive, leading to leading to costly economic contraction and resource misallocation. Given these insights, central bank monetary policy frameworks should identify the conditions under which front-loaded tightening is appropriate. This requires enhanced models and better sectoral data to gauge underlying inflationary forces, improve forecasts, and guide the fine-tuning of policy responses. A first step in the right direction may involve collecting more frequent data for prices by sector and supply constraints to determine if key sectors are bumping against supply bottlenecks. Also, understanding structural factors such as how different sectors set prices and the links between them would provide additional valuable insights. Several central banks plan to review their policy frameworks in the coming months. These reviews present an opportunity to incorporate well-defined escape clauses in their frameworks to tackle inflationary pressures when aggregate Phillips curves steepen. Forward guidance should internalize those escape clauses and allow for front-loading of tightening in such situations. Such added flexibility should allow central banks to be better prepared in the future and help safeguard their hard-earned credibility. —This blog is based on Chapter 2 of the October 2024 World Economic Outlook, “The Great Tightening: Insights from The Recent Inflation Episode.” This blog also reflects contributions by Emine Boz, Thomas Kroen, Galip Kemal Ozhan, Nicholas Sander, and Sihwan Yang.

Jeff Kearns Managing Editor IMF Blog jkearns@IMF.org   Thank you again for your interest in IMF Blog. Read more of our latest content here. Take good care!