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- April 2008
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World economic outlook (International Monetary Fund)
World economic outlook : a survey by the staff of the International Monetary Fund. — Washington, DC : International Monetary Fund, 1980–
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ASSUMPTIONS AND CONVENTIONS
A number of assumptions have been adopted for the projections presented in the World Economic Outlook. It has been assumed (1) that real effective exchange rates will remain constant at their average levels during January 30–February 27, 2008, except for the currencies participating in the European exchange rate mechanism II (ERM II), which are assumed to remain constant in nominal terms relative to the euro; (2) that established policies of national authorities will be maintained (for specific assumptions about fiscal and monetary policies in industrial countries, see Box A1); (3) that the average price of oil will be $95.50 a barrel in 2008 and $94.50 a barrel in 2009, and remain unchanged in real terms over the medium term; (4) that the six-month London interbank offered rate (LIBOR) on U.S. dollar deposits will average 3.1 percent in 2008 and 3.4 percent in 2009; (5) that the three-month euro deposits rate will average 4.0 percent in 2008 and 3.6 percent in 2009; and (6) that the six-month Japanese yen deposit rate will yield an average of 1.0 percent in 2008 and of 0.8 percent in 2009. These are, of course, working hypotheses rather than forecasts, and the uncertainties surrounding them add to the margin of error that would in any event be involved in the projections. The estimates and projections are based on statistical information available through end-March 2008.
The following conventions have been used throughout the World Economic Outlook:
… to indicate that data are not available or not applicable;
— to indicate that the figure is zero or negligible;
– between years or months (for example, 2006–07 or January–June) to indicate the years or months covered, including the beginning and ending years or months;
― between years or months (for example, 2006/07) to indicate a fiscal or financial year.
“Billion” means a thousand million; “trillion” means a thousand billion.
“Basis points” refer to hundredths of 1 percentage point (for example, 25 basis points are equivalent to ¼ of 1 percentage point).
In figures and tables, shaded areas indicate IMF staff projections.
If no source is listed on tables and figures, data are drawn from the World Economic Outlook database.
When countries are not listed alphabetically, they are ordered on the basis of economic size.
Minor discrepancies between sums of constituent figures and totals shown are due to rounding.
As used in this report, the term “country” does not in all cases refer to a territorial entity that is a state as understood by international law and practice. As used here, the term also covers some territorial entities that are not states but for which statistical data are maintained on a separate and independent basis.
FURTHER INFORMATION AND DATA
This report on the World Economic Outlook is available in full on the IMF’s website, www.imf.org. Accompanying it on the website is a larger compilation of data from the WEO database than in the report itself, consisting of files containing the series most frequently requested by readers. These files may be downloaded for use in a variety of software packages.
Inquiries about the content of the World Economic Outlook and the WEO database should be sent by mail, electronic mail, or telefax (telephone inquiries cannot be accepted) to:
World Economic Studies Division
International Monetary Fund
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The analysis and projections contained in the World Economic Outlook are integral elements of the IMF’s surveillance of economic developments and policies in its member countries, of developments in international financial markets, and of the global economic system. The survey of prospects and policies is the product of a comprehensive interdepartmental review of world economic developments, which draws primarily on information the IMF staff gathers through its consultations with member countries. These consultations are carried out in particular by the IMF’s area departments together with the Policy Development and Review Department, the Monetary and Capital Markets Department, and the Fiscal Affairs Department.
The analysis in this report has been coordinated in the Research Department under the general direction of Simon Johnson, Economic Counsellor and Director of Research. The project has been directed by Charles Collyns, Deputy Director of the Research Department, and Subir Lall, Acting Division Chief, Research Department. Tim Callen helped coordinate the early stages of the project before moving to a new assignment.
The primary contributors to this report are Roberto Cardarelli, Kevin Cheng, Stephan Danninger, Selim Elekdag, Thomas Helbling, Deniz Igan, Florence Jaumotte, Ben Jones, Tim Lane, Valerie Mercer-Blackman, Paul Mills, Gianni De Nicolò, Jonathan Ostry, Rodney Ramcharan, Alessandro Rebucci, Alasdair Scott, Nikola Spatafora, Jon Strand, Natalia Tamirisa, Irina Tytell, Toh Kuan, Gavin Asdorian, To-Nhu Dao, Stephanie Denis, Nese Erbil, Angela Espiritu, Elaine Hensle, Patrick Hettinger, Susana Mursula, Bennett Sutton, and Ercument Tulun. Mahnaz Hemmati, Laurent Meister, and Emory Oakes managed the database and the computer systems. Sylvia Brescia, Jemille Colon, and Sheila Tomilloso Igcasenza were responsible for word processing. Other contributors include Eduardo Borensztein, Marcos Chamon, Hamid Faruqee, Lyudmyla Hvozdyk, M. Ayhan Kose, Kornélia Krajnyák, Michael Kumhof, Douglas Laxton, Jaewoo Lee, Paolo Mauro, Steven Symansky, Stephan Tokarick, and Johannes Wiegand. External consultants include Warwick McKibbin, Tommaso Monacelli, Ian Parry, Luca Sala, Arvind Subramanian, Kang Yong Tan, and Shang-Jin Wei. Linda Griffin Kean of the External Relations Department edited the manuscript and coordinated the production of the publication.
The analysis has benefited from comments and suggestions by staff from other IMF departments, as well as by Executive Directors following their discussion of the report on March 19 and 21, 2008. However, both projections and policy considerations are those of the IMF staff and should not be attributed to Executive Directors or to their national authorities.
This World Economic Outlook presents the IMF staff’s view of the world economy in spring 2008, with our assessment of current conditions and prospects and with an in-depth analysis of several key elements that will affect conditions and prospects in the months and years ahead. This report has been prepared by a team composed primarily of the staff of the World Economic Studies division, ably led by Charles Collyns and, since January, Subir Lall. I would also like to recognize the particular contribution of Tim Callen, who led this division for three years and who helped shape this issue of the World Economic Outlook during its design and development. In addition, I must emphasize, as always, that other IMF staff, both within the Research Department and across the organization, have played critical roles in producing this report, through direct contributions to all the chapters and through a continual process of collegial interaction and productive feedback.
The world economy has entered new and precarious territory. The U.S. economy continues to be mired in the financial problems that first emerged in subprime mortgage lending but which have now spread much more broadly. Strains that were once thought to be limited to part of the housing market are now having considerable negative effects across the entire economy, with rising defaults, falling collateral, and tighter credit working together to create a powerful and hard-to-defeat financial decelerator.
In addition to serious problems at the intersection of credit and the real economy, the United States remains plagued by profound errors in risk management among its leading financial institutions. Problems that were once thought to be limited to issues surrounding liquidity in short-term money markets—and thought capable of being dealt with as such— have cascaded across much of the financial sector, triggering repeated waves of downgrades, upward adjustment of losses for both U.S. and European banks, and now an apparently unstoppable move toward some significant degree of global deleveraging.
This cutback in lending and the associated attempt to reduce risks played a major role in a most dramatic pair of events—both of which happened as this World Economic Outlook entered its final stages of preparation. First, one of the five largest U.S. investment banks, Bear Stearns, was sold under difficult circumstances— including the presumed imminence of a far-reaching default. Second, and just as headline-grabbing, were the virtually unprecedented steps taken by the Federal Reserve to prevent Bear Stearns’s problems from spreading. These steps have had a definite stabilizing effect, at least for now.
In our view, the continuing deep correction in the U.S. housing market and the unresolved financial sector problems have led the U.S. economy to the verge of recession. In fact, we are now anticipating that the United States will indeed slip into recession—meaning that it will experience two or more quarters of negative growth—during the course of 2008, before starting a moderate recovery at some point during 2009.
The effects on the rest of the world are likely to be significant. We have already reduced our expectations for growth in Europe and much of the emerging world. Our revised global growth forecast is 3.7 percent, down from 4.9 percent in 2007, which represents a pronounced slowdown. However, I would stress that achieving growth even at this level will require that most advanced economies experience only mild slowdowns and that many emerging economies be able to keep their rapid pace of growth largely on track.
In addition to problems within the financial sector, there are two main short-run vulnerabilities for the global economy, both of which are covered in considerable detail in this World Economic Outlook. The first is that housing prices may adjust downward significantly in many other advanced economies (first figure). Although Chapter 3 shows that the particular dynamics of the housing market in the United States are not matched by those in other countries, it also shows that housing may now play a more marked role in the business cycle more broadly—as the nature of mortgage financing has changed and as valuations have increased almost everywhere over the past 10 years.
House Price Gaps
Source: IMF staff calculations, as described in Box 3.1x.
Number of Major Commodity Groups in Boom Phase and Global Industrial Production 1
Source: IMF, Commodity Price System; IMF, International Financial Statistics; and IMF staff calculation
1 Major commodity groups are defined as oil, metals, food, beverages, and agricultural raw materials.
The second potential vulnerability is, of course, commodity prices. Chapter 5 examines the role of commodity prices in contributing to the strong performance of many emerging and developing economies in recent years. It is striking how the surging tide of commodity prices over the past five years (second figure) has lifted almost all commodity-based boats around the world. Although there is some reason to believe that the countries exporting commodities are now better able than in the past to withstand a serious downturn, we continue to urge caution: commodity prices have fallen, on average, by 30 percent during significant global slowdowns over the past 30 years.
All eyes now turn to the world’s leading emerging economies. They have come of economic age in the past half-decade—diversifying their exports, strengthening their domestic economies, and improving their policy frameworks. It is conceivable that their strong momentum, together with some timely policy adjustments, can sustain both their domestic demand and the global economy.
At this moment, however, these emerging economies find themselves beset not by impending recession, but rather by inflation pressures. In particular, the financial dynamics of dollar depreciation and increasing financial market uncertainty have combined with continuing strong demand growth in the emerging economies and sluggish supply responses by commodity producers in such a way as to keep upward pressure on food and energy prices despite the darkening clouds over the global economy.
Therefore, at the very time when preparations for countercyclical measures would seem to be warranted, leading emerging economies find themselves trying hard to take the edge off inflation.
These immediate issues are compelling, but we must not lose sight of the longer-term challenges, including the global challenge of climate change. The IMF can contribute to the important current debate by analyzing the macroeco-nomic consequences of climate change, which can be far-reaching and quick-acting. Chapter 4 has a particular focus on the macroeconomic impact of mitigation strategies and argues that well-designed policy frameworks can limit carbon and related emissions without having a major negative effect on growth.
In addition to the compelling medium-term case for containing emissions, we urgently need a more coherent global approach to energy pricing. It is essential that increases in fuel prices be passed on to final consumers, thus allowing the price mechanism to play an appropriate role across the global economy in reducing demand (and limiting inflation pressure) whenever supply conditions or financial events push commodity prices up. Attempts to protect consumers from the true short-, medium-, or long-run costs of using fossil fuels are likely to prove worse than futile.
Economic Counsellor and Director, Research Department
Global Economic Environment
The global expansion is losing speed in the face of a major financial crisis (Chapter 1). The slowdown has been greatest in the advanced economies, particularly in the United States, where the housing market correction continues to exacerbate financial stress. Among the other advanced economies, growth in western Europe has also decelerated, although activity in Japan has been more resilient. The emerging and developing economies have so far been less affected by financial market developments and have continued to grow at a rapid pace, led by China and India, although activity is beginning to slow in some countries.
At the same time, headline inflation has increased around the world, boosted by the continuing buoyancy of food and energy prices. In the advanced economies, core inflation has edged upward in recent months despite slowing growth. In the emerging markets, headline inflation has risen more markedly, reflecting both strong demand growth and the greater weight of energy and particularly food in consumption baskets.
Commodity markets have continued to boom despite slowing global activity. Strong demand from emerging economies, which has accounted for much of the increase in commodity consumption in recent years, has been a driving force in the price run-up, while biofuel-related demand has boosted prices of major food crops. At the same time, supply adjustments to higher prices have lagged, notably for oil, and inventory levels in many markets have declined to medium- to long-term lows (see Appendix 1.2). The recent run-up in commodity prices also seems to have been at least partly due to finan-cial factors, as commodities have increasingly emerged as an alternative asset class.
The financial shock that erupted in August 2007, as the U.S. subprime mortgage market was derailed by the reversal of the housing boom, has spread quickly and unpredictably to inflict extensive damage on markets and institutions at the core of the financial system. The fallout has curtailed liquidity in the interbank market, weakened capital adequacy at major banks, and prompted the repricing of risk across a broad range of instruments, as discussed in more detail in the April 2008 Global Financial Stability Report. Liquidity remains seriously impaired despite aggressive responses by major central banks, while concern about credit risks has intensified and extended far beyond the sub-prime mortgage sector. Equity prices have also retreated as signs of economic weakness have intensified, and equity and currency markets have remained volatile.
These financial dislocations and associated deleveraging are affecting both bank and non-bank channels of credit in the advanced economies, and evidence is gathering of a broad credit squeeze—although not yet a full-blown credit crunch. Bank lending standards in the United States and western Europe are tightening, the issuance of structured securities has been curtailed, and spreads on corporate debt have risen sharply. The impact is most severe in the United States and is contributing to a further deepening of the housing market correction. In western Europe, the main spillovers have been through banks most directly exposed to U.S. subprime securities and disruptions in interbank and structured securities markets.
Recent financial market stress has also had an impact on foreign exchange markets. The real effective exchange rate for the U.S. dollar has declined sharply since mid-2007 as foreign investment in U.S. bonds and equities has been dampened by reduced confidence in both the liquidity of and the returns on such assets, as well as by the weakening of U.S. growth prospects and interest rate cuts. The decline in the value of the U.S. dollar has boosted net exports and helped bring the U.S. current account deficit down to less than 5 percent of GDP by the fourth quarter of 2007, over 1½ percent of GDP lower than its peak in 2006. The main counterpart to the decline of the dollar has been appreciation of the euro, the yen, and other floating currencies such as the Canadian dollar and some emerging economy currencies. However, exchange rate movements have been less marked for a number of countries with large current account surpluses—notably China and oil-exporting countries in the Middle East.
Direct spillovers to emerging and developing economies have been less pronounced than in previous periods of global financial market distress, although capital inflows have moderated in recent months and issuance activity has been subdued. A number of countries that had relied heavily on short-term cross-border borrowing have been affected more substantially. Trade spillovers from the slowdown in the advanced economies have been limited so far and are more visible in economies that trade heavily with the United States. As a result, growth among emerging and developed economies has continued to be generally strong and broadly balanced across regions, with many countries still facing rising inflation rates from buoyant food and fuel prices and strong domestic demand.
Underpinning the resilience of the emerging and developing economies are their increasing integration into the global economy and the broad-based nature of the current commodity price boom, which have boosted exports, foreign direct investment, and domestic investment in commodity-exporting countries to a greater degree than during earlier booms. As explored in Chapter 5, commodity exporters have been able to make progress toward diversifying their export bases, including by increasing manufacturing exports, and the share of trade among the emerging and developing economies themselves has increased. Strengthened macroeconomic frameworks and improved institutional environments have been important factors behind these favorable developments. As a result, the growth performance of emerging and developing economies has become less dependent on the advanced economy business cycle, although spillovers have clearly not been eliminated.
Outlook and Risks
Global growth is projected to slow to 3.7 percent in 2008, ½ percentage point lower than at the time of the January World Economic Outlook Update and 1¼ percentage points lower than the growth recorded in 2007. Moreover, growth is projected to remain broadly unchanged in 2009. The divergence in growth performance between the advanced and emerging economies is expected to continue, with growth in the advanced economies generally expected to fall well below potential. The U.S. economy will tip into a mild recession in 2008 as the result of mutually reinforcing cycles in the housing and financial markets, before starting a modest recovery in 2009 as balance sheet problems in financial institutions are slowly resolved (Chapter 2). Activity in western Europe is also projected to slow to well below potential, owing to trade spillovers, financial strains, and negative housing cycles in some countries. By contrast, growth in emerging and developing economies is expected to ease modestly but remain robust in both 2008 and 2009. The slowdown reflects efforts to prevent overheating in some countries as well as trade and financial spillovers and some moderation in commodity prices.
The overall balance of risks to the short-term global growth outlook remains tilted to the downside. The IMF staff now sees a 25 percent chance that global growth will drop to 3 percent or less in 2008 and 2009—equivalent to a global recession. The greatest risk comes from the still-unfolding events in financial markets, particularly the potential for deep losses on structured credits related to the U.S. subprime mortgage market and other sectors to seriously impair financial system balance sheets and cause the current credit squeeze to mutate into a full-blown credit crunch. Interaction between negative financial shocks and domestic demand, particularly through the housing market, remains a concern for the United States and to a lesser degree for western Europe and other advanced economies. There is some upside potential from projections for domestic demand in the emerging economies, but these economies remain vulnerable to trade and financial spillovers. At the same time, risks related to inflationary pressures have risen, reflecting the price surge in tight commodity markets and the upward drift of core inflation.
Policymakers around the world are facing a diverse and fast-moving set of challenges, and although each country’s circumstances differ, in an increasingly multipolar world it will be essential to meet these challenges broadly, taking full account of cross-border interactions. In the advanced economies, the pressing tasks are dealing with financial market dislocations and responding to downside risks to growth—but policy choices should also take into account inflation risks and longer-term concerns. Many emerging and developing economies still face the challenge of ensuring that strong current growth does not drive a buildup in inflation or vulnerabilities, but they should be ready to respond to slowing growth and more difficult financing conditions if the external environment deteriorates sharply.
Monetary policymakers in the advanced economies face a delicate balancing act between alleviating the downside risks to growth and guarding against a buildup in inflation. In the United States, rising downside risks to output, amid considerable uncertainty about the extent, duration, and impact of financial turbulence and the deterioration in labor market conditions, justifies the Federal Reserve’s recent deep interest rate cuts and a continuing bias toward monetary easing until the economy moves to a firmer footing. In the euro area, although current inflation is uncomfortably high, prospects point to its falling back below 2 percent during 2009, in the context of an increasingly negative outlook for activity. Accordingly, the European Central Bank can afford some easing of the policy stance. In Japan, there is merit in keeping interest rates on hold, although there would be some limited scope to reduce interest rates from already-low levels if there were a substantial deterioration in growth prospects.
Beyond these immediate concerns, recent financial developments have fueled the continuing debate about the degree to which central banks should take asset prices into account in setting monetary policy. In this context, Chapter 3 looks at connections between housing cycles and monetary policy. It concludes that recent experience seems to support giving greater weight to house price movements in monetary policy decisions, especially in economies with more developed mortgage markets where “financial accelerator” effects have become more pronounced. This could be achieved within a risk-management framework for monetary policy by “leaning against the wind” when house prices move rapidly or when prices have moved out of normal valuation ranges, although it would not be feasible or desirable for monetary policy to adopt specific house price objectives.
Fiscal policy can play a useful stabilizing role in advanced economies in the event of a downturn in economic activity, although it should not jeopardize efforts aimed at consolidating fiscal positions over the medium term. In the first place, there are automatic stabilizers that should provide timely fiscal support, without jeopardizing progress toward medium-term objectives. In addition, there may be justification for additional discretionary stimulus in some countries, given present concern about the strength of recessionary forces and concern that financial dislocations may have weakened the normal monetary policy transmission mechanism, but any such stimulus must be timely, well targeted, and quickly unwound. In the United States, where automatic stabilizers are relatively small, the recent legislation to provide additional stimulus for an economy under stress seems fully justified, and room may need to be found for some additional public support for housing and financial markets. In the euro area, automatic stabilizers are more extensive and should be allowed to play out fully around a deficit path that is consistent with steady advancement toward medium-term objectives. Countries whose medium-term objectives are well in hand can provide some additional discretionary stimulus if needed. However, in other countries, the ability to allow even automatic stabilizers to operate in full may be limited by high levels of public debt and current adjustment plans that are insufficient for medium-term sustainability. In Japan, net public debt is projected to remain at high levels despite recent consolidation efforts. In the context of an economic downturn, automatic stabilizers could be allowed to operate, but their impact on domestic demand would be small, and there would be little scope for additional discretionary action.
Policymakers need to continue strong efforts to deal with financial market turmoil in order to avoid a full-blown crisis of confidence or a credit crunch. The immediate priorities, explored in more detail in the April 2008 Global Financial Stability Report, are to rebuild counterparty confidence, reinforce the capital and financial soundness of institutions, and ease liquidity strains. Additional initiatives to help support the U.S. housing market, including possible use of the public sector balance sheet, could help to reduce uncertainties about the evolution of the financial system, although care would be needed to avoid inducing undue moral hazard. Longer-term reforms include improving mortgage market regulation, promoting the independence of rating agencies, broadening supervision, strengthening the framework of supervisory cooperation, and improving crisis resolution mechanisms.
Emerging and Developing Economies
Emerging and developing economies face the challenges of controlling inflation while being alert to downside risks from the slowdown in the advanced economies and the increased stress in financial markets. In some countries, further monetary policy tightening may be needed to keep inflation under control. With a flexible exchange rate regime, currency appreciation will tend to provide useful support for monetary tightening. Countries whose exchange rates are heavily managed vis-à-vis the U.S. dollar have less room to respond because rising interest rates may encourage heavier capital inflows. China and other countries that have diversified economies would benefit from moving toward more flexible regimes that would provide greater scope for monetary policy. For many Middle Eastern oil exporters, the exchange rate peg to the U.S. dollar constrains monetary policy, and it will be important that the current buildup in fiscal spending be calibrated to account for the cyclical position of these economies and that priority be given to spending aimed at alleviating supply bottlenecks.
Fiscal and financial policies can also play useful roles in preventing overheating and related problems. Expenditure restraint can help moderate domestic demand, lessen the need for monetary tightening, and ease pressures from short-term capital inflows. Vigilant financial supervision—promoting appropriately tight lending standards and strong risk management in domestic financial institutions—can pay dividends both by moderating the demand impulse from rapid credit growth and by reducing the buildup of balance sheet vulnerabilities.
At the same time, policymakers should be ready to respond to a more negative external environment, which could undercut trade performance and stifle capital inflows. In many countries, strengthened policy frameworks and public sector balance sheets will allow for more use than in the past of countercyclical monetary and fiscal policies. In China, the consolidation of the past few years provides ample room to support the economy through fiscal policy, such as by accelerating public investment plans and advancing the pace of reforms to strengthen social safety nets, health care, and education. In many Latin American countries, well-established inflation-targeting frameworks would provide the basis for monetary easing in the event of both a downturn in activity and an alleviation of inflation pressures. Automatic fiscal stabilizers could be allowed to operate, although there would be little room for discretionary fiscal stimulus, given still-high public debt levels. Some emerging and developing economies that have large current account deficits or other vulnerabilities and are reliant on capital inflows may need to respond by tightening policies promptly to maintain confidence.
Multilateral Initiatives and Policies
Broadly based efforts to deal with global challenges have become indispensable. In the event of a severe global downturn, there would be a case for providing temporary fiscal support in a range of countries that have made good progress in recent years in securing sound fiscal positions. Providing fiscal stimulus across a broad group of countries that would benefit from stronger aggregate demand could prove much more effective than isolated efforts, given the inevitable cross-border leakages from added spending in open economies. It is still early to launch such an approach, but it would be prudent for countries to start contingency planning to ensure a timely response in the event that such support becomes necessary.
Reducing risks associated with global current account imbalances remains an important task. It is encouraging that some progress is being made in implementing the strategy endorsed by the International Monetary and Financial Committee and the more detailed policy plans laid out by participants in the IMF-sponsored Multilateral Consultation on Global Imbalances aimed at rebalancing domestic demand across countries, with supportive movements in real exchange rates (see Box 1.3). This road map remains relevant but should be used flexibly to take account of the changing global context. Reducing trade barriers also remains an important priority, but the slow progress toward completing the Doha Round has been disappointing. Rising trade has been a key source of the recent strong performance of the global economy—and the recent progress toward global poverty reduction—and a renewed push in this area remains essential.
Recent commitments to developing a post-Kyoto framework for joint action to address climate change are very welcome. As discussed in Chapter 4, efforts to adapt to and mitigate the buildup of greenhouse gases have important macroeconomic consequences. The chapter finds that these macroeconomic consequences can be contained, provided efforts to limit emissions are based on effective carbon pricing that reflects the damages emissions inflict. Such carbon pricing should be applied across countries to maximize the efficiency of abatement, should be flexible to avoid volatility, and should be equitable so as not to put undue burdens on the countries least able to bear them.