International Monetary Fund. Research Dept.
Published Date:
October 2001
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The following remarks by the Acting Chair summarize the Executive Board’s discussion of the Interim World Economic Outlook, which took place on December 11, 2001.

Directors observed that at the time of the October 2001 World Economic Outlook update, the global economic outlook in the near term was being affected by a sharp slowdown in growth in almost all major regions of the world, accompanied by a marked decline in trade growth, significantly lower commodity prices, and deteriorating financing conditions in emerging markets. Nevertheless, in the immediate period prior to the terrorist attacks of September 11, there appeared to be a reasonable prospect of recovery in late 2001. However, more recent data, on which the interim World Economic Outlook revisions are based, indicate that the situation before the attacks was in fact weaker than earlier projected in many regions, including the United States, Europe, and Japan. Directors accordingly concluded that the tragic events of September 11 had exacerbated an already very difficult situation in the global economy.

Impact of September 11

Directors observed that, in the aftermath of the September 11 attacks, consumer and business confidence weakened further across the globe. There was a significant initial impact on demand and activity, particularly in the United States, although there are signs that this is now beginning to stabilize. Turning to financial markets, Directors observed that there had been an initial generalized shift away from risky assets in both mature and emerging markets, including a substantial deterioration in financing conditions for emerging market economies. Between end-September and early December 2001, however, financial markets generally strengthened, as equity markets recovered and the earlier flight to quality began to reverse. A few Directors cautioned that this recovery in financial markets may reflect an overreaction following the attacks and the subsequent monetary response, and should not be seen as indicating that a recovery is in sight. Movements in major exchange rates on net have been moderate, while commodity prices have fallen back further, especially for oil, as the outlook for global growth has weakened.

Directors expressed particular concern about the synchronicity of the slowdown across nearly all regions, reflected, among other things, in the recent data on employment declines and the softening in labor markets. They noted that, to a considerable extent, this synchronicity is the result of common shocks, including the initial increase in oil prices and the bursting of the information technology bubble. Increased international linkages, particularly in the financial and corporate sectors, have also played a role.

Directors noted that the more pronounced economic slowdown and worsening financing conditions have adversely affected many emerging markets through trade and confidence channels, constraining capital flows, including foreign direct investment. Countries with substantial external financing requirements remain vulnerable to potential reassessments of global and domestic economic prospects and to further shocks to international capital markets. Nevertheless, Directors considered that recently most emerging markets have become more resilient to external shocks as a result of improved macroeconomic management, broad-based structural reforms, and flexible exchange rates. They also noted signs of increased investors' discrimination across countries, which was helping to limit contagion risks.

Directors observed that developing countries and, in particular, the poorest countries are being hurt by weaker external demand and falling commodity prices, with oil exporters particularly affected. Nonfuel commodity exporters will also be affected by further weakness in already depressed prices, although for some the benefits from lower oil prices will limit the increase in external financing requirements. Thus, while growth is projected to be relatively well sustained for the group as a whole, the outlook for individual countries varies widely. Directors were also concerned that this overall outlook may mask the true impact on poverty, as lower prices for agricultural goods will hurt rural areas, while the benefits of lower oil prices tend to accrue in relatively more prosperous urban areas.

Outlook for 2002

Directors considered that the current outlook remains subject to considerable uncertainty, reflecting in part the inherent unpredictability of changes in confidence and financial market sentiment, and evidenced for example by the sharp increase in dispersion in private sector forecasts. Notwithstanding these uncertainties, they observed that a number of factors should help to support recovery in 2002. First, policymakers have generally moved quickly to support activity, and, with much of the resulting stimulus still in the pipeline, significant support will be provided to activity in the course of 2002. Second, oil prices have weakened sharply as a result of weakening demand, which could provide support for global activity, although there are clearly negative effects for oil producers, including a number of highly indebted countries. Third, the completion of ongoing inventory corrections will provide support to demand. Finally, the strengthening of economic fundamentals in many countries in recent years—notably lower inflation, generally improved fiscal positions, stronger external financial positions in many emerging market economies, especially in Asia, and the shift toward more flexible exchange rates—has increased the room for policy maneuver and resilience to external shocks.

Risks to Recovery

Directors acknowledged that the above factors may support the possibility that recovery in 2002 could come more rapidly than presently expected, particularly if the policy stimulus in the pipeline produces a faster or stronger impact and if confidence revives more sharply than assumed. Nevertheless, Directors believed that the possibility of a worse outcome still remains the major global policy concern, and identified three interlinked areas of risk. First, confidence and activity in the United States may pick up more slowly than currently expected, possibly as a result of the imbalances accumulated in the past. There are also downside risks to activity in the other major currency areas. These could reinforce the already synchronized downturn, with negative consequences for developing countries through a reduced desire for risk taking in financial markets and lower commodity prices. Second, the outlook for many emerging market economies will continue to depend on developments in global risk aversion; while recent developments have been encouraging, market access for many countries remains limited. Third, many Directors noted that the imbalances in the global economy remain an important source of risk. All Directors agreed that, against this background, the economic situation merits continued close monitoring.

Policy Challenges Ahead

Directors believed that the primary challenge faced by policymakers is how best to support the prospects for recovery and to limit the risks attendant on a deeper and longer downturn. Given the synchronicity of the slowdown, policies in both advanced and developing countries must be viewed in a global perspective to ensure that there is adequate global demand. Monetary policy—the most flexible instrument—has appropriately played the primary role to date, and most Directors agreed that there remains room for further easing if weakness persists, including through a more aggressive approach to monetary easing in Japan.

Turning to fiscal policy, given the limitations of monetary policy in the current environment of weak confidence and excess capacity, most Directors agreed that fiscal policy should also play a role, particularly through the operation of the automatic stabilizers, although the room for maneuver will depend on each country's medium-term consolidation objectives. Additional stimulus presently under consideration in the United States could be helpful if implemented sufficiently rapidly while demand is still weak, and should be carefully designed to shore up consumer confidence and boost activity in the short run, without exacerbating medium-term fiscal pressures. In Europe, some Directors thought that the automatic stabilizers should be allowed to operate in full, and a few Directors saw room for well-designed moderate discretionary policies in some countries in the region. In Japan, the recent supplementary budget has gone a significant way toward avoiding a withdrawal of stimulus in the current recessionary environment. Structural reforms in Europe and, particularly, in Japan, remain crucial, both to improve growth potential and boost confidence, and to help reduce global imbalances over the longer term.

In developing and emerging markets, there is generally considerably less room for policy maneuver to support growth, although where it exists it should be used. In particular, Directors were of the view that, in the difficult external environment, many emerging market economies have little alternative but to implement even much deeper reforms to strengthen (or even restore) their economic fundamentals, and ensure future access to finance at acceptable spreads so as to sustain growth. More generally, domestic policies should be geared to achieving early external adjustment where necessary, accompanied by structural reforms—particularly of the financial and corporate sectors—to help reduce vulnerability.

For its part, the international community should provide strong support for such efforts, through the international financial institutions and other channels, and due attention will need to be paid to the appropriate mix between adjustment and financing. For the poorest countries, additional concessional financing may be required. A few Directors reiterated the call for improved market access to industrial country markets, as well as for a rapid increase in official development assistance toward the U.N. target of 0.7 percent of GNP.

Finally, there remains an important question as to the potential long-term impact of increased security concerns and other related issues, including transportation costs on economic activity. While it is impossible to estimate their size with any precision at this stage, and there will be a short-term impact on productivity, Directors noted that such costs are likely to be concentrated in a few industries, and, at this stage, it is not anticipated that they will be large enough or long lasting to have a significant impact on medium- and long-term growth trends, although a few Directors considered that more widespread effects remain possible. Nonetheless, this reinforces the need to press forward with structural and other reforms designed to increase long-run productive potential. Directors underlined, in this connection, that the agreement reached at the World Trade Organization meetings in Doha in November to launch new trade negotiations is of particular importance, as they can be expected to contribute substantially to global economic growth over the medium term.

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