- International Monetary Fund. Research Dept.
- Published Date:
- April 2007
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World economic outlook (International Monetary Fund)
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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 that real effective exchange rates will remain constant at their average levels during August 22–September 19, 2007, 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; that established policies of national authorities will be maintained (for specific assumptions about fiscal and monetary policies in industrial countries, see Box A1); that the average price of oil will be $68.52 a barrel in 2007 and $75.00 a barrel in 2008, and remain unchanged in real terms over the medium term; that the six-month London interbank offered rate (LIBOR) on U.S. dollar deposits will average 5.2 percent in 2007 and 4.4 percent in 2008; that the three-month euro deposits rate will average 4.0 percent in 2007 and 4.1 percent in 2008; and that the six-month Japanese yen deposit rate will yield an average of 0.9 percent in 2007 and of 1.1 percent in 2008. 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-September 2007.
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, 2005–06 or January–June) to indicate the years or months covered, including the beginning and ending years or months;
∕ between years or months (for example, 2005/06) 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 percent point).
In figures and tables, shaded areas indicate IMF staff projections.
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 Internet site, 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.
The following changes have been made to streamline the Statistical Appendix of the World Economic Outlook. Starting with this issue, the printed version of the World Economic Outlook will carry only Part A Tables in the Statistical Appendix section.
Part A contains Tables 1, 2, 3, 6, 7, 8, 11, 20, 25, 26, 31, 35, 43, and 44 from the previous issues of the World Economic Outlook; Tables 1.2 and 1.3, which used to be in the main text of the report; and a new table on private capital flows. Tables in Part A present summary data for both advanced economies and emerging market and developing countries in the categories of Output, Inflation, Financial Policies, Foreign Trade, Current Account Transactions, Balance of Payments and External Financing, Flow of Funds, and Medium-Term Baseline Scenario.
Part B of the Statistical Appendix contains the remaining tables. The complete Statistical Appendix, which includes both Part A and Part B Tables, will be available only via the Internet at www.imf.org/external/pubs/ft/weo/2007/02/index.htm.
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 Tim Callen, Division Chief, Research Department.
The primary contributors to this report are Roberto Cardarelli, Kevin Cheng, Selim Elekdag, Florence Jaumotte, Ben Jones, Michael Keen, Ayhan Kose, Toh Kuan, Subir Lall, Valerie Mercer-Blackman, John Norregaard, Chris Papageorgiou, Hossein Samiei, Alasdair Scott, Martin Sommer, Nikola Spatafora, Jon Strand, Natalia Tamirisa, and Petia Topalova. Sergei Antoshin, Gavin Asdorian, To-Nhu Dao, Stephanie Denis, Nese Erbil, Angela Espiritu, Patrick Hettinger, Susana Mursula, Murad Omoev, Allen Stack, Bennett Sutton, and Ercument Tulun provided research assistance. Mahnaz Hemmati, Laurent Meister, and Emory Oakes managed the database and the computer systems. Sylvia Brescia, Celia Burns, Jemille Colon, and Sheila Tomilloso Igcasenza were responsible for word processing. Other contributors include Andrew Benito, Luis Catão, Gianni De Nicolò, Hamid Faruqee, Thomas Helbling, Michael Kumhof, Tim Lane, Douglas Laxton, Gian-Maria Milesi-Ferretti, Emil Stavrev, Thierry Tressel, and Johannes Wiegand. External consultants include Nancy Birdsall, Menzie Chin, Gordon Hanson, Massimiliano Marcellino, and Carlos Végh. Archana Kumar 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 September 17 and 24, 2007. 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.
Throughout a turbulent summer, the World Economic Outlook team at the IMF has worked hard to stay ahead of developments, to refine our analytical work, and to keep our forecasts up to date. Led by Charles Collyns and Tim Callen, the World Economic Studies division has worked closely with other IMF staff to produce a WEO that is close to current developments while providing some much-needed longer-term perspective. We hope that it will help you both understand what has happened in the past few months as well as reflect on what might be in store for the next 15 months.
The world economy has entered an uncertain and potentially difficult period. The financial turmoil of August and September threatens to derail what has been an excellent half-decade of global growth. The problems in credit markets have been severe, and while the first phase is now over, we are still waiting to see exactly how the consequences will play out.
Still, the situation at present is one with threats rather than actual major negative outcomes on macroeconomic aggregates. At this point, we expect global growth to slow in 2008, but remain at a buoyant pace. Growth in the United States is expected to remain subdued. Problems in the housing sector are more intense than previously expected, and the disruption of credit is likely to have further impact. We expect some slowing in Japan, where the second quarter was disappointing, and in Europe, where banks were involved to a surprising degree with instruments and vehicles exposed to the U.S. subprime sector.
The good news is that emerging market and developing countries weathered the recent financial storm and are providing the basis for strong global growth in 2008. For the first time, China and India are making the largest country-level contributions to world growth (in purchasing-power-parity terms; see the figure). China is also making the largest contribution at market prices. More generally, emerging market and developing countries are reaping the benefits of careful macroeconomic management over the past decade. While there are some potential vulnerabilities, and there is no room for complacency going forward, emerging markets should remain strong in the foreseeable future.
Emerging Markets Now the Major Engine of Global Growth
Source: IMF staff calculations.
In terms of global risks, we see most of these as being on the downside for growth, that is, unexpected developments are more likely to push growth down rather than push it up. Our growth fan chart shows probabilities both above and below our forecast, based on our previous forecast errors, but the skewness of the chart—based on our reading of what could push the global economy away from our central forecast—is almost entirely to the downside.
Some of these risks have received considerable attention, including those in housing markets and financial sectors. But some are more surprising, including the fact that oil prices remain high and that sharp food price increases are contributing to inflation concerns in emerging market and developing countries. A key unknown is what will happen in Europe. Until the events of this summer, Europe was in the upswing of its cycle, with Germany in particular emerging as a driver of growth, moving beyond the long, difficult process of reunification. But the serious disruptions in the market for interbank liquidity and the difficulties experienced by some European banks in recent months were largely unexpected. Quite how these developments will affect the real economy remains to be seen.
I would also stress that the implications for global imbalances remain uncertain. It seems likely that the U.S. current account deficit will decline relative to GDP, in part because the dollar has depreciated further since the summer—its value is down more than 20 percent from its recent peak in 2002. Fortunately, we have in place a framework for cooperative actions by the key countries involved with imbalances; this was a major outcome of the IMF’s Multilateral Consultation this year. Oil producers continue to scale up their spending on infrastructure and investments. China remains determined to rebalance its demand so as to lower its current account surplus. Europe and Japan continue with the process of structural reform, which should help with restructuring and boost domestic demand. We expect that this framework will facilitate the gradual decline of imbalances and reduce risks of disruptive changes in exchange rates, but this situation requires continued careful attention.
Turning to our analytical chapters, Chapter 3 highlights a major challenge for many emerging market and developing countries—how to manage large capital inflows. These inflows slowed this summer, but recent indications are that they are again picking up. The chapter assesses what we can learn from recent episodes of capital inflows around the world, and it looks at what kinds of macroeconomic policies help to ensure that growth post-inflows remains strong. It turns out that intervening in exchange markets, either with or without sterilization, has not been successful in limiting real exchange rate appreciation or avoiding a deceleration in post-inflow growth. What really helps is being careful with fiscal spending. The lesson here is not that a country needs to cut spending when there are inflows, but rather that it needs to exercise fiscal restraint. The greater caution of some leading emerging markets in this regard since the late 1990s is commendable and has definitely contributed in part to their resilience today. I hope other countries will learn the same lesson.
Chapter 4 takes a longer-term perspective and looks at what has happened to inequality around the world, particularly during the recent surge in various forms of globalization. While we have written extensively, including in the April 2007 World Economic Outlook, about the benefits of globalization, the findings in this chapter should be seen as more cautionary. In almost all countries, inequality has increased in recent years. The authors find that increased trade is not the culprit. Rather, it seems likely that the spread of new technology around the world, both in general and through foreign direct investment, has disproportionately benefited people who are better educated. The implication, of course, is not to try to prevent the adoption of new technology—such an approach would be sure to derail growth. Rather the policy objective should be to provide the education and other social services (such as affordable health care, a reasonable-cost pension system, and so on) to ensure that as many people as possible can find and keep high-productivity jobs. It would be unwise to ignore the issue of growing inequality; globalization is a key source of rising world prosperity, but more effective policy actions are needed to make sure that these benefits are well shared.
Chapter 5 offers hope but also some caution regarding the longer-term prospects of the global economy. Looking back as far as possible with comparable data (which takes us to around 1960), it is clear that the past half-decade has seen the strongest and most broadly based run of global growth since the 1960s. This was not a fluke, but rather the result of improved frameworks for both monetary and fiscal policies, as well as serious institutional improvements in many middle- and lower-income countries. At the same time, there was some luck involved—inflation has been low, globally, in part because of low-cost manufactured goods (part of the globalization process) and because private capital flows have been relatively stable. It would be unwise to expect that there will not be shocks going forward, and the chapter makes recommendations that should help ensure that these shocks do not have major repercussions.
In sum, the main message of this World Economic Outlook is that, as long as policy fundamentals remain strong and institutions are not undermined, the global economy should grow rapidly, with the continued involvement of almost all countries. Events of the past few months have been a major test of global financial stability, and some unexpected weaknesses have emerged. As long as those remain contained within a few industrial countries and are addressed in a timely fashion, the impact on world growth should be small.
The key, in the years ahead, is to make sure that emerging market and developing countries can continue to grow rapidly and without major disruptions. Macroeconomic stability is necessary but not sufficient for economic growth. We have to continue the process of trade liberalization, allow capital to flow to more productive opportunities in poorer countries, and—most important—make sure that the benefits of growth are widely shared across all countries and by as many people as possible within countries. We would do well to antic pate further serious shocks, both downside and upside, and to work harder to make sure that the policies and institutions in place can withstand these shocks.
Economic Counsellor and Director, Research Department
The global economy grew strongly in the first half of 2007, although turbulence in financial markets has clouded prospects. While the 2007 forecast has been little affected, the baseline projection for 2008 global growth has been reduced by almost ½ percentage point relative to the July 2007 World Economic Outlook Update. This would still leave global growth at a solid 4¾ percent, supported by generally sound fundamentals and strong momentum in emerging market economies. Risks to the outlook, however, are firmly on the downside, centered around the concern that financial market strains could deepen and trigger a more pronounced global slowdown. Thus, the immediate focus of policymakers is to restore more normal financial market conditions and safeguard the expansion. Additional risks to the outlook include potential inflation pressures, volatile oil markets, and the impact on emerging markets of strong foreign exchange inflows. At the same time, longer-term issues such as population aging, increasing resistance to globalization, and global warming are a source of concern.
Global Economic Environment
The global economy continued to expand vigorously in the first half of 2007, with growth running above 5 percent (Chapter 1). China’s economy gained further momentum, growing by 11½ percent, while India and Russia continued to grow very strongly. These three countries alone have accounted for one-half of global growth over the past year. Robust expansions also continued in other emerging market and developing countries, including low-income countries in Africa. Among the advanced economies, growth in the euro area and Japan slowed in the second quarter of 2007 after two quarters of strong gains. In the United States, growth averaged 2¼ percent in the first half of 2007 as the housing downturn continued to apply considerable drag.
Inflation has been contained in the advanced economies, but it has risen in many emerging market and developing countries, reflecting higher energy and food prices. In the United States, core inflation has gradually eased to below 2 percent. In the euro area, inflation has generally remained below 2 percent this year, but energy and food price increases contributed to an uptick in September; while in Japan, prices have essentially been flat. Some emerging market and developing countries have seen more inflation pressures, reflecting strong growth and the greater weight of rising food prices in their consumer price indices. The acceleration in food prices has reflected pressure from the rising use of corn and other food items for biofuel production and poor weather conditions in some countries (Appendix 1.1). Strong demand has kept oil and other commodity prices high.
Financial market conditions have become more volatile. As discussed in the October 2007 Global Financial Stability Report (GFSR), credit conditions have tightened as increasing concerns about the fallout from strains in the U.S. subprime mortgage market led to a spike in yields on securities collateralized with such loans as well as other higher-risk securities. Uncertainty about the distribution of losses and rising concerns about counterparty risk saw liquidity dry up in segments of the financial markets. Equity markets initially retreated, led by falling valuations of financial institutions, although prices have since recovered, and long-term government bond yields declined as investors looked for safe havens. Emerging markets have also been affected, although by relatively less than in previous episodes of global financial market turbulence, and asset prices remain high by historical standards.
Prior to the recent turbulence, central banks around the world were generally tightening monetary policy to head off nascent inflation pressures. In August, however, faced by mounting market disruptions, major central banks injected liquidity into money markets to stabilize short-term interest rates. In September, the Federal Reserve cut the federal funds rate by 50 basis points, and financial markets expect further reductions in the coming months. Expectations of policy tightening by the Bank of England, Bank of Japan, and European Central Bank have been rolled back since the onset of the financial market turmoil. Among emerging markets, some central banks also provided liquidity to ease strains in interbank markets, but for others the principal challenge remains to address inflation concerns.
The major currencies have largely continued trends observed since early 2006. The U.S. dollar has continued to weaken, although its real effective value is still estimated to be above its medium-term fundamental level. The euro has appreciated but continues to trade in a range broadly consistent with fundamentals. The Japanese yen has rebounded strongly in recent months but remains undervalued relative to medium-term fundamentals. The renminbi has continued to appreciate gradually against the U.S. dollar and on a real effective basis, but China’s current account surplus has widened further and its international reserves have soared.
Outlook and Risks
In the face of turbulent conditions in financial markets, the baseline projections for global growth have been marked down moderately since the July World Economic Outlook Update, although growth is still expected to continue at a solid pace. The global economy is projected to grow by 5.2 percent in 2007 and 4.8 percent in 2008—the latter forecast is 0.4 percentage point lower than previously expected. The largest downward revisions to growth are in the United States, which is now expected to grow at 1.9 percent in 2008; in countries where spillovers from the United States are likely to be largest; and in countries where the impact of continuing financial market turmoil is likely to be more acute (see Chapter 2).
The balance of risks to the baseline growth outlook is clearly on the downside. While the underlying fundamentals supporting growth are sound and the strong momentum in increasingly important emerging market economies is intact, downside risks emanating from the financial markets and domestic demand in the United States and western Europe have increased. While the recent repricing of risk and increased discipline in credit markets could strengthen the foundations for future expansion, it raises the near-term risks to growth. The extent of the impact on growth will depend on how quickly more normal market liquidity returns and on the extent of the retrenchment in credit markets. The IMF staff’s baseline forecast is based on the assumption that market liquidity is gradually restored in the coming months and that the interbank market reverts to more normal conditions, although wider credit spreads are expected to persist. Nonetheless, there remains a distinct possibility that turbulent financial market conditions could continue for some time. An extended period of tight credit conditions could have a significant dampening impact on growth, particularly through the effect on housing markets in the United States and some European countries. Countries in emerging Europe and the Commonwealth of Independent States region with large current account deficits and substantial external financing inflows would also be adversely affected if capital inflows were to weaken.
Several other risks could also have an impact on the global outlook. While downside risks to the outlook from inflation concerns have generally been somewhat reduced by recent developments, oil prices have risen to new highs and a further spike in prices cannot be ruled out—reflecting limited spare production capacity. Risks related to persistent global imbalances still remain a concern.
Policymakers around the world continue to face the immediate challenge of maintaining strong noninflationary growth, a challenge heightened by recent turbulent global financial conditions. In the advanced economies, after a period of tightening that has brought monetary stances close to or above neutral, central banks have addressed the recent drying up of market liquidity and associated financial sector risks while continuing to base monetary policy decisions on judgments about the economic fundamentals. In the United States, signs that growth was likely to continue below trend would justify further interest rate reductions, provided that inflation risks remain contained. In the euro area, monetary policy can stay on hold over the near term, reflecting the downside risks to growth and inflation from financial market turmoil. However, as these risks dissipate, further tightening eventually may be required. In the event of a more protracted slowdown, an easing of monetary policy would need to be considered. In Japan, while interest rates will eventually need to return to more normal levels, such increases should await clear signs that prospective inflation is moving decisively higher and that concerns over recent market volatility have waned.
In due course, lessons will need to be drawn from the current episode of turbulent global financial market conditions. One set of issues concerns the various approaches that central banks have used to provide liquidity to relieve financial strains and the linkage of this liquidity support with financial safety nets. A series of regulatory issues will need to be addressed, as discussed in the October 2007 GFSR. Greater attention will need to be given to ensuring adequate transparency and disclosure by systemically important institutions. It will also be relevant to examine the regulatory approach to treating liquidity risk, the relevant perimeter around financial institutions for risk consolidation, the approach to rating complex financial products, and whether the existing incentive structure ensures adequate risk assessment throughout the supply chain of structured products.
Substantial progress has been made toward fiscal consolidation during the present expansion in advanced economies, but more needs to be done to ensure fiscal sustainability in the face of population aging. Much of the recent improvement in fiscal positions has reflected rapid revenue growth driven by strong growth in profits and high-end incomes, and it is not clear to what extent these revenue gains will be sustained. Further, current budgetary plans envisage limited additional progress in reducing debt ratios from current levels over the next few years. Governments should adopt more ambitious medium-term consolidation plans, together with reforms to tackle the rising pressures on health and social security spending, although in most countries there is scope to let the automatic fiscal stabilizers operate in the event of a downturn.
A number of emerging markets still face overheating pressures and rising food prices, and further monetary tightening may be required. Moreover, notwithstanding recent financial market developments, strong foreign exchange inflows are likely to continue to complicate the task of policymakers. As discussed in Chapter 3, there is no simple formula for dealing with these foreign exchange inflows. Countries need to take a pragmatic approach, finding an appropriate blend of measures suited to their particular circumstances and longer-term goals. Fiscal policy is likely to play a key role. While fiscal positions have improved, this reflects strong revenue growth generated by high commodity prices that may not be sustained. At the same time, government spending in many countries has accelerated, which has added to the difficulties of managing strong foreign exchange inflows. The avoidance of public spending booms, particularly in emerging Europe but also in Latin America, would help both in managing inflows and in continuing to reduce public debt levels. In fuel-exporting countries, however, there is scope to further increase spending, subject to absorptive capacities and the cyclical position of the economy. A tightening of prudential standards in financial systems and steps to liberalize controls on capital outflows can all play useful roles. In some cases, greater exchange rate flexibility would provide more room for better monetary control. Specifically for China, further upward flexibility of the renminbi, along with measures to reform the exchange rate regime and boost consumption, would also contribute to a necessary rebalancing of demand and to an orderly unwinding of global imbalances.
Across all countries, a common theme is the need to take advantage of the opportunities created by globalization and technological advances, while doing more to ensure that the benefits of these ongoing changes are well distributed across the broad population. A key part of this agenda is to make sure that markets work well, with priorities being to boost productivity in the financial and service sectors in Europe and Japan; resist protectionist pressures in the United States and Europe; and improve infrastructure, develop financial systems, and strengthen the business environment in emerging market and developing countries.
Globalization is often blamed for the rising inequality observed in most countries and regions. Chapter 4 of this report finds that technological advances have contributed the most to the recent rise in inequality, but increased financial globalization—and foreign direct investment in particular—has also played a role. Contrary to popular belief, increased trade globalization is actually associated with a decline in inequality. It is important that policies help ensure that the gains from globalization and technological change are more broadly shared across the population. Reforms to strengthen education and training would help to ensure that workers have the appropriate skills for the emerging “knowledge-based” global economy. Policies that increase the availability of finance to the poor would also help, as would further trade liberalization that boosts agricultural exports from developing countries.
Chapter 5 of this report examines the current global expansion from a historical perspective. It finds that not only has growth been stronger than in other recent cycles, but also the benefits are being more widely shared across the world and economic volatility has been lower. Indeed, better monetary and fiscal policies, improved institutions, and increased financial development mean that it is likely that business cycles will be of longer duration and lesser magnitude than in the past. Nevertheless, the prospects for future stability should not be overstated, and recent increased financial market volatility has underlined concerns that favorable conditions may not continue. The abrupt end to the period of strong and sustained growth in the 1960s and early 1970s provides a useful cautionary lesson of what can happen if policies do not adjust to tackle emerging risks in a timely manner.
In some key areas, joint actions across countries will be crucial. The recent slow progress with the Doha Trade Round is deeply disappointing, and major countries should demonstrate leadership to re-energize the process of multilateral trade liberalization. Concerns about climate change and energy security also clearly require a multilateral approach. As discussed in Appendix 1.2, global warming may be the world’s largest collective action problem where the negative consequences of individual activities are felt largely by others. It will be important that countries come together to develop a market-based framework that balances the long-term costs of carbon emissions against the immediate economic costs of mitigation. Energy policy should focus less on trying to secure national sources of energy and more on ensuring the smooth operation of oil and other energy markets, encouraging diversification of energy sources (for example, by reducing barriers to trade in biofuels), and paying greater attention to price-based incentives to curb the growth of energy consumption.
Welcome progress has been made toward developing a joint approach toward tackling global imbalances, and this now needs to be followed through. The IMF’s Multilateral Consultation on Global Imbalances with key countries represents the first use of an innovative approach to addressing systemic global challenges. The Consultation provided a forum to strengthen mutual understanding of the issues, to reaffirm support for the International Monetary and Financial Committee (IMFC) Strategy of sustaining global growth while reducing imbalances, and for each country to indicate specific policies consistent with the Strategy. The result of the Consultation was a set of policy plans that, according to IMF staff analysis, will make a significant contribution toward the goals of the IMFC Strategy. With the agreement of the participants in the Consultation, the implementation of the policy plans will be the subject of regular IMF surveillance.