This edition of the World Economic Outlook explores how a dramatic escalation of the financial crisis in September 2008 provoked an unprecedented contraction of activity and trade, despite active policy responses. It presents economic projections for 2009 and 2010, and also looks beyond the current crisis, considering factors that will shape the landscape of the global economy over the medium term, as businesses and households seek to repair the damage. The analysis also outlines the difficult policy challenges presented by the overwhelming imperative to take all steps necessary to restore financial stability and revive the global economy, and the longer-run need for national actions to be mutually supporting. The first of two analytical chapters, "What Kind of Economic Recovery?" explores the shape of the eventual recovery. The second, "The Transmission of Financial Stress from Advanced to Emerging and Developing Economies," focuses on the role of external financial linkages and financial stress in transmitting economic shocks.
Against the backdrop of the biggest financial crisis since the Great Depression, this chapter studies how financial stress in advanced economies is transmitted to emerging economies. Crises in advanced economies have a large common effect on the banking sectors, stock markets, and foreign exchange markets of emerging economies. There is also a sizable country-specific effect, which appears to be magnified by the intensity of financial linkages. In more normal times, reducing individual countries’ vulnerabilities, such as current account and fiscal deficits, can lower the level of financial stress in emerging economies, but such improvements provide little insulation from the transmission of a major financial shock from the advanced economies. Given the current banking crises in advanced economies, reductions in banking flows to emerging economies could be large and long-lasting. The major negative spillovers and repercussions of this for both advanced and emerging economies argue for a coordinated policy response.
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