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- Published Date:
- October 2009
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- Assumptions and Conventions
- Joint Foreword to World Economic Outlook and Global Financial Stability Report
- Executive Summary
- Chapter 1. Global Prospects and Policies
- The Global Recession Is Ending
- Deleveraging and Slow Job Growth Ahead
- Improving, but Still Difficult, Financial Conditions
- Sluggish Real Sector Dynamics
- Continued, but Diminishing, Support from Policy
- A Subdued Recovery and Vulnerability to Mild Deflation
- Beyond 2010: How Will the Global Economy Rebalance?
- Risks to a Sustained Recovery
- Policy Challenges: Reconciling Short- and Medium-Term Objectives
- Appendix 1.1. Commodity Market Developments and Prospects
- Chapter 2. Country and Regional Perspectives
- The U.S. Economy Is Stabilizing as the Crisis Subsides
- Asia: From Rebound to Recovery?
- Europe: A Sluggish Recovery Lies Ahead
- Commonwealth of Independent States: A Difficult Recovery for Some and Damage Containment for Others
- Other Advanced Economies: On the Path to Recovery
- Latin America and the Caribbean: Policy Frameworks Have Promoted Resilience
- Middle East: Strengthening Growth Prospects
- Africa: Regaining Momentum
- Chapter 3. Lessons for Monetary Policy from Asset Price Fluctuations
- Chapter 4. What’s the Damage? Medium-Term Output Dynamics after Financial Crises
- Annex: IMF Executive Board Discussion of the Outlook, September 2009
- Statistical Appendix
- What’s New
- Data and Conventions
- Classification of Countries
- General Features and Composition of Groups in the World Economic Outlook Classification
- List of Tables
- World Economic Outlook, Selected Topics 201
- Box 1.1 Trade Finance and Global Trade: New Evidence from Bank Surveys
- Box 1.2 Were Financial Markets in Emerging Economies More Resilient than in Past Crises?
- Box 1.3 Will the Recovery Be Jobless?
- Box 1.4 Risks from Real Estate Markets
- Box 1.5 From Deficit to Surplus: Recent Shifts in Global Current Accounts
- Box 1.6 What Do Options Markets Tell Us about Commodity Price Prospects?
- Box 1.7 What Explains the Rise in Food Price Volatility?
- Box 4.1 A Historical Perspective on International Financial Crises
- A1. Economic Policy Assumptions Underlying the Projections for Selected Economies
- 1.1 Overview of the World Economic Outlook Projections
- Table 1.2 Commodity Price Developments, 2008-09
- Table 1.3 Commodity Consumption and Market Share
- Table 1.4 Global Oil Demand and Production by Region
- Table 2.1 Advanced Economies: Real GDP, Consumer Prices, and Unemployment
- Table 2.2 Selected Asian Economies: Real GDP, Consumer Prices, and Current Account Balance
- Table 2.3 Advanced Economies: Current Account Positions
- Table 2.4 Selected Emerging European Economies: Real GDP, Consumer Prices, and Current Account Balance
- Table 2.5 Commonwealth of Independent States: Real GDP, Consumer Prices, and Current Account Balance
- Table 2.6 Selected Western Hemisphere Economies: Real GDP, Consumer Prices, and Current Account Balance
- Table 2.7 Selected Middle Eastern Economies: Real GDP, Consumer Prices, and Current Account Balance
- Table 2.8 Selected African Economies: Real GDP, Consumer Prices, and Current Account Balance
- Table 3.1 House Price and Stock Price Busts from 1970 to 2008
- Table 3.2 Classification of Observations Based on Variable Thresholds
- Table 3.3 Parameters and Performance of Policy Regimes in Reaction to Financial Shocks
- Table 3.4 Parameters and Performance of Policy Regimes in Reaction to Productivity Shocks
- Table 3.5 Percentiles Used as Thresholds for Alarms
- Table 3.6 Marginal Probabilities Based on Probit Regressions
- Table 4.1 Output Losses versus Initial Conditions
- Table 4.2 Output Losses versus Postcrisis Conditions and Policies
- Table 4.3 Robustness: Output Losses versus Initial Conditions, Crisis Severity Omitted
- Table 4.4 Robustness: Output Losses versus Postcrisis Conditions, Crisis Severity Omitted
- Figure 1.1 Current and Forward-Looking Indicators
- Figure 1.2 Global Indicators
- Figure 1.3 Developments in Mature Credit Markets
- Figure 1.4 Emerging Market Conditions
- Figure 1.5 External Developments
- Figure 1.6 Measures of Monetary Policy and Liquidity in Selected Advanced Economies
- Figure 1.7 General Government Fiscal balances and Public Debt
- Figure 1.8 Public Support to Ease Financial Stress
- Figure 1.9 Global Outlook
- Figure 1.10 Global Inflation
- Figure 1.11 Potential Growth and Unemployment Rates
- Figure 1.12 GDP Growth
- Figure 1.13 Global Imbalances
- Figure 1.14 Risks to the Global Outlook
- Figure 1.15 Global Scenarios
- Figure 1.16 Commodity and Petroleum Prices
- Figure 1.17 Commodity Prices in Global Recessions
- Figure 1.18 World Energy Market Developments
- Figure 1.19 Developments in Metal Markets
- Figure 1.20 Recent Developments in Markets for Major Food Crops
- Figure 2.1 United States: Signs of Stabilization
- Figure 2.2 Advanced and Emerging Asia: Can the Recovery Be Sustained?
- Figure 2.3 Europe: A Slow Rebound
- Figure 2.4 Europe: Challenges Ahead
- Figure 2.5 Commonwealth of Independent States (CIS): An Arduous Road to Recovery
- Figure 2.6 Australia, Canada, and New Zealand: Turning the Page
- Figure 2.7 Latin America: Recovery Is within Reach
- Figure 2.8 Middle East: Resuming Growth
- Figure 2.9 Africa: Resilient Economies
- Figure 3.1 Asset Price Busts
- Figure 3.2 Selected Macroeconomic Variables before and during House Price Busts
- Figure 3.3 Selected Macroeconomic Variables before and during Stock Price Busts
- Figure 3.4 Selected Macroeconomic Variables before and during High-Cost and Other House Price Busts, 1985–2008
- Figure 3.5 The Probability of an Asset Price Bust
- Figure 3.6 The Failure of the Indicators to Predict an Asset Price Bust
- Figure 3.7 Recent Developments in House and Stock Prices
- Figure 3.8 Warning Signs for Recent House Price Busts
- Figure 3.9 Macroeconomic Patterns Underlying Recent House Price Booms
- Figure 3.10 Recent House Price Booms and Household Balance Sheets
- Figure 3.11 Monetary Policy before House Price Busts
- Figure 3.12 Inflation and Output for Advanced Economies in Recent Years
- Figure 3.13 House Prices and Monetary Conditions
- Figure 3.14 Stock Prices and Monetary Conditions
- Figure 3.15 Effects of a Financial Shock
- Figure 3.16 Effects of a Productivity Shock
- Figure 3.17 Optimal Weight on Nominal Credit in the Macroprudential Rule
- Figure 4.1 Medium-Term Output per Capita after Financial Crises: Case Studies
- Figure 4.2 Distribution of Crises across Time and Economy Type
- Figure 4.3 Methodology Example (Korea 1997)
- Figure 4.4 Output Evolution after Banking and Currency Crises
- Figure 4.5 Medium-Term Growth after Banking Crises
- Figure 4.6 Output Decomposition
- Figure 4.7 Demand-Side Decomposition
- Figure 4.8 Output Evolution versus Precrisis Investment
- Figure 4.9 Output Evolution versus Precrisis Imbalances
- Figure 4.10 Output Evolution versus Financial Development and Income
- Figure 4.11 Output, Twin Crises, and Financial Openness
- Figure 4.12 Employment Losses and Employment Protection Legislation
- Figure 4.13 Output Losses and Macroeconomic Stimulus
- Figure 4.14 Postcrisis Associations of Key Variables with Output Losses
- Figure 4.15 Output Evolution after Banking Crises: Alternative Measures of Precrisis Trend
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 July 30–August 27, 2009, 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 for selected economies, see Box A1); that the average price of oil will be $61.53 a barrel in 2009 and $76.50 a barrel in 2010, and will 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 1.2 percent in 2009 and 1.4 percent in 2010; that the three-month euro deposit rate will average 1.2 percent in 2009 and 1.6 percent in 2010; and that the six-month Japanese yen deposit rate will yield an average of 0.7 percent in 2009 and 0.6 percent in 2010. 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 mid-September 2009.
The following conventions are used throughout the World Economic Outlook:
- . . . to indicate that data are not available or not applicable;
- – 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 (WEO) 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 reflect 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 version of 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 is included in the report itself, including 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, e-mail, or fax (telephone inquiries cannot be accepted) to
World Economic Studies Division
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www.imf.org/weoforum Fax: (202) 623–6343
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—namely, the African Department, Asia and Pacific Department, European Department, Middle East and Central Asia Department, and Western Hemisphere Department—together with the Strategy, Policy, and Review Department; the Monetary and Capital Markets Department; and the Fiscal Affairs Department.
The analysis in this report was coordinated in the Research Department under the general direction of Olivier Blanchard, Economic Counsellor and Director of Research. The project was directed by Jörg Decressin, Division Chief, Research Department.
The primary contributors to this report are Abdul Abiad, Ravi Balakrishnan, Petya Koeva Brooks, Stephan Danninger, Antonio Fatás, Prakash Kannan, Daniel Leigh, Pau Rabanal, Alasdair Scott, Marco Terrones, and Irina Tytell. Toh Kuan, Gavin Asdorian, Stephanie Denis, Angela Espiritu, Murad Omoev, Andy Salazar, Min Kyu Song, Ercument Tulun, and Jessie Yang provided research assistance. Mahnaz Hemmati and Emory Oakes managed the database and the computer systems. Jemille Colon, Tita Gunio, Shanti Karunaratne, Patricia Medina, and Sheila Tomilloso Igcasenza were responsible for word processing. Julio Prego provided graphics support. Other contributors include Irena Asmundson, Kevin Cheng, Nese Erbil, Deniz Igan, Thomas Helbling, Armine Khachatryan, Heejin Kim, Prakash Loungani, Shaun Roache, Jair Rodriguez, Marina Rousset, and Mika Saito. Charles Collyns and David Romer of the Research Department provided advice and encouragement. Jordi Galí was an external consultant, and 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 September 16, 2009. 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.
Joint Foreword to World Economic Outlook and Global Financial Stability Report
The Recovery Has Started, and the Challenge Is to Sustain It
The global economy is expanding again, and financial conditions have improved markedly. It will still take some time, however, until the outlook for employment improves significantly.
Emerging and developing economies are further ahead on the road to recovery, led by a resurgence in Asia—in general, emerging economies have withstood the financial turmoil much better than expected based on past experience, which reflects improved policy frame-works. However, gains in activity are now being seen more broadly, including in the major advanced economies. Financial market sentiment and risk appetite have rebounded, banks have raised capital and wholesale funding markets have reopened, and emerging market risks have eased.
The triggers for this rebound are strong public policies across advanced and emerging economies that, together with measures deployed by the IMF at the international level, have allayed concerns about systemic financial collapse, supported demand, and all but eliminated fears of a global depression. These fears had contributed to the steepest drop in global activity and trade since World War II. Central banks reacted quickly with exceptionally large interest rate cuts as well as unconventional measures to inject liquidity and sustain credit. Governments launched major fiscal stimulus programs, while assessing their banks with stress tests and supporting them with guarantees and capital injections. And the IMF made use of its enhanced lending capacity and more flexible facilities to help emerging and developing economies cope with the risks associated with the crisis. Together, these measures reduced uncertainty and increased confidence.
But complacency must be avoided. Despite these advances, the pace of recovery is expected to be slow and, for quite some time, insufficient to decrease unemployment. Also, poverty could increase significantly in a number of developing economies where real GDP per capita is contracting in 2009 for the first time in a decade. Activity may pick up quickly in the short term. Yet the forces that are driving the current rebound are partly temporary in nature, including major fiscal stimulus, central banks’ support for credit markets, and restocking following exceptionally large cutbacks in production and drawdowns of inventories. These forces will diminish during the course of 2010.
A further key constraint on the pace of recovery will be limits on credit availability. Bank deleveraging will constrain the supply of bank credit for the remainder of 2009 and into 2010 in both the United States and Europe, where credit supply is even more bank-dependent. Bank balance sheets have benefited from capital-raising efforts and positive earnings reports but will remain under pressure as a result of continuing credit deterioration. Our analysis suggests that U.S. banks have recognized somewhat more than half their projected losses from impaired assets through 2010. In Europe, loss recognition is less advanced, reflecting differences in the economic cycle. Although stronger bank earnings are supporting capital levels, they are not expected to fully offset write-downs over the next 18 months. Moreover, steady-state earnings are likely to be lower in the postcrisis environment, and reforms under way to bank regulation are expected to reduce net revenues and result in more costly self-insurance through higher capital and liquidity requirements. Projections for emerging economies assume that capital flows, which took a major hit over the past year, will stabilize or grow moderately. Credit growth will continue to fall or stay at very low levels, and this will hold back investment, with the notable exception of China. Significant credit contraction is generally unlikely, except in parts of emerging Europe and the Commonwealth of Independent States.
Meanwhile, consumption and investment are gaining strength only slowly, held back by the need for balance sheet repair, high excess capacity as well as financing constraints, and rising unemployment, which is expected to peak at over 10 percent of the labor force in advanced economies. Consumption will be particularly weak in advanced economies, especially those that experienced credit booms, housing bubbles, and large current account deficits, such as the United States and the United Kingdom, and in a number of other (especially emerging) European economies. U.S. consumers, in particular, are likely to maintain substantially higher saving rates than before the crisis.
Accordingly, the World Economic Outlook projects activity contracting by about 1 percent in 2009 and expanding by about 3 percent in 2010, which is still well below rates achieved before the crisis.
Downside risks remain a concern. The main risk is that private demand in advanced economies remains very weak. If so, policymakers may be confronted with the difficult choice of either maintaining fiscal stimulus, raising issues of debt sustainability, or phasing out the fiscal stimulus, raising the danger of adverse interactions between real activity, the health of the financial sector, and the fiscal situation. However, there is also potential for positive surprises. Specifically, reduced fears about a 1930s-style crash in activity and an accompanying strong rebound in financial market sentiment could drive a larger-than-projected short-term increase in consumption and investment.
It is still too early for policymakers to relax their efforts to restore financial sector health and support demand with expansionary macroeconomic policies. The challenge is to ensure that continued short-term support does not distort incentives and endanger public balance sheets, with damaging consequences for the medium term. Furthermore, policies must begin to address key medium-term challenges, including the need for reforming financial systems, boosting potential growth, and rebalancing the patterns of global demand.
Notwithstanding already large deficits and rising public debt in many countries, fiscal stimulus needs to be sustained until the recovery is on a firmer footing and may even need to be amplified or extended beyond current plans if downside risks to growth materialize. However, fiscal policy is likely to become increasingly less effective in supporting demand in the absence of reassurances to investors and taxpayers that deficits and debt will eventually be rolled back. This is likely to require major efforts to constrain spending by initiating entitlement reforms and by committing to large reductions in deficits once the recovery is on a solid footing. The credibility of such reductions could usefully be supported with more robust fiscal frameworks, including suitable fiscal rules and strong enforcement mechanisms that help rein in spending pressures when good times return.
The key issues facing monetary policymakers are when to start tightening and how to unwind large central bank balance sheets. Advanced and emerging economies face different challenges. In advanced economies, central banks can (with few exceptions) afford to maintain accommodative conditions for an extended period because inflation is likely to remain subdued as long as output gaps remain wide. Moreover, monetary policy will need to accommodate the impact of the gradual withdrawal of fiscal support. If and when necessary, instruments exist to start tightening monetary conditions even while central bank balance sheets remain much larger than usual. The pace at which the buildup in central bank balance sheets should be unwound depends on progress in normalizing market conditions and the types of interventions in place. Supported by appropriate pricing, short-term liquidity operations are already unwinding naturally as market conditions improve. However, it could take much longer to unwind the buildup in illiquid assets on some central bank balance sheets.
The situation is more varied across emerging economies, but the moment for starting to remove monetary accommodation is likely to materialize sooner than in advanced economies. In some countries, warding off risks for new asset price bubbles may call for greater exchange rate flexibility, to allow monetary policy tightening relative to easy stances in advanced economies.
Policymakers face two major financial sector challenges. The first is to ensure that markets and banks can support economic recovery. This calls especially for renewed efforts to increase bank capital and repair bank balance sheets. So far, only very partial progress has been made on this front. Official stress tests are important instruments through which the condition of banks can be diagnosed in order to design appropriate strategies for the recapitalization and restructuring of viable banks and for the careful resolution of nonviable banks. In addition, exit strategies from public support need to be clearly articulated to help guide markets. Programs need to be phased out gradually, using market-based incentives to encourage reduced reliance on public support. Moreover, clarity on new capital regulation, liquidity risk requirements, provisioning, and accounting standards and, where possible, agreement on resolution strategies are essential for banks to be able to determine how to deploy their resources and which business lines are likely to be profitable in the future.
The second challenge is to put in place financial reforms that forestall a similar crisis in the future. This will require a major overhaul of prudential policies, which must not be jeopardized by growing confidence that the greatest crisis dangers are past, or fears that national competitive advantages might be lost, or concerns that first-best solutions are beyond reach for technical reasons. Four issues deserve particular attention. First, the perimeter of regulation needs to be broadened and made more flexible, covering all systemically important institutions alongside incentives to preclude further buildups of institutions currently considered “too big or too connected to fail.” Second, effective market discipline needs to be encouraged through greater transparency and disclosure and reform of governance in financial institutions. Third, macroprudential frameworks must induce banks to build more buffers—by raising capital and making provisions in good times that can be used in bad times. And, fourth, international collaboration and coordination need to be improved to adequately cope with the challenges posed by cross-border institutions. Looking forward, to avoid a similar crisis, there is a need not just for better rules—through enhanced regulation—but also for adequate enforcement of the rules—through effective supervision—and for prudent behavior by financial institutions—through suitable internal risk-management processes.
Rebalancing Global Demand
Achieving sustained healthy growth over the medium term also depends critically on rebalancing the pattern of global demand. Specifically, many current account surplus economies that have followed export-led growth strategies will need to rely more on domestic demand growth to offset likely subdued domestic demand in deficit economies that have undergone asset price (stock and housing) busts. By the same token, many external deficit countries will need to rely less on domestic demand and more on external demand. This will require significant structural reforms, many of which are also necessary to boost potential output, which has taken a hit as a result of the crisis. Key are measures to repair financial systems, improve corporate governance and financial intermediation, support public investment, and improve social safety nets.
With respect to social policies, rising unemployment will present a major challenge in many advanced economies that must be met with support for incomes, retraining for the jobless, and measures that facilitate wage adjustment in response to shocks. The crisis has also been a setback to poverty-alleviation efforts in many low-income economies, and continued strong donor support will be necessary to safeguard the major progress these countries have made in stabilizing their economies.
|Olivier Blanchard||José Viñals|
|Economic Counsellor||Financial Counsellor|
After a deep global recession, economic growth has turned positive, as wide-ranging public intervention has supported demand and lowered uncertainty and systemic risk in financial markets. The recovery is expected to be slow, as financial systems remain impaired, support from public policies will gradually have to be withdrawn, and households in economies that suffered asset price busts will continue to rebuild savings while struggling with high unemployment. The key policy requirements remain to restore financial sector health while maintaining supportive macroeco-nomic policies until the recovery is on a firm footing. However, policymakers need to begin preparing for an orderly unwinding of extraordinary levels of public intervention.
Global Recession Is Ending, but a Subdued Recovery Lies Ahead
The global economy appears to be expanding again, pulled up by the strong performance of Asian economies and stabilization or modest recovery elsewhere. In the advanced economies, unprecedented public intervention has stabilized activity and has even fostered a return to modest growth in several economies. Emerging and developing economies are generally further ahead on the road to recovery, led by a resurgence in Asia. The recent rebound in commodity prices and supportive policies are helping many of these economies. Many countries in emerging Europe and the Commonwealth of Independent States have been hit particularly hard by the crisis, and developments in these economies are generally lagging those elsewhere.
The pace of recovery is slow, and activity remains far below precrisis levels. The pickup is being led by a rebound in manufacturing and a turn in the inventory cycle, and there are some signs of gradually stabilizing retail sales, returning consumer confidence, and firmer housing markets. As prospects have improved, commodity prices have staged a comeback from lows reached earlier this year, and world trade is beginning to pick up.
The triggers for this rebound are strong public policies across advanced and many emerging economies that have supported demand and all but eliminated fears of a global depression. These fears contributed to the steepest drop in global activity and trade since World War II. Central banks reacted quickly with exceptionally large interest rate cuts as well as unconventional measures to inject liquidity and sustain credit. Governments launched major fiscal stimulus programs while supporting banks with guarantees and capital injections. Together, these measures reduced uncertainty and increased confidence, fostering an improvement in financial conditions, as evidenced by strong rallies across many markets and a rebound of international capital flows. However, the environment remains very challenging for lower-tier borrowers. More generally, as emphasized in the October 2009 Global Financial Stability Report (GFSR), the risk of a reversal is a significant market concern, and a number of financial stress indicators remain elevated.
Looking ahead, the policy forces that are driving the current rebound will gradually lose strength, and real and financial forces, although gradually building, remain weak. Specifically, fiscal stimulus will diminish and inventory rebuilding will gradually lose its influence. Meanwhile, consumption and investment are gaining strength only slowly, as financial conditions remain tight in many economies. Thus, after contracting by about 1 percent in 2009, global activity is forecast to expand by about 3 percent in 2010, which is well below the rates achieved before the crisis. These projections reflect modest upward revisions to those in the July 2009 WEO Update.
- Advanced economies are projected to expand sluggishly through much of 2010, with unemployment continuing to rise until later in the year. Annual growth in 2010 is projected to be about 1¼ percent, following a contraction of 3½ percent in 2009. The recovery of activity is more clearly evident on a fourth-quarter-over-fourth-quarter basis: from 2009:Q4 to 2010:Q4, real GDP is expected to rise by about 1¾ percent, up from an expansion of about ½ percent (annualized) during the second half of 2009 and a 2 percent contraction in the first half.
- In emerging economies, real GDP growth is forecast to reach almost 5 percent in 2010, up from 1¾ percent in 2009. The rebound is driven by China, India, and a number of other emerging Asian economies. Other emerging economies are staging modest recoveries, supported by policy stimulus and improving global trade and financial conditions.
Downside risks to growth are receding gradually but remain a concern. The main short-term risk is that the recovery will stall. Premature exit from accommodative monetary and fiscal policies seems a significant risk because the policy-induced rebound might be mistaken for the beginning of a strong recovery in private demand. In general, the fragile global economy still seems vulnerable to a range of shocks, including rising oil prices, a virulent return of H1N1 flu, geopolitical events, or resurgent protectionism.
However, short-term risks are not only on the downside, as evidenced by the recent, more-rapid-than-expected improvement in financial conditions. In particular, the policy-induced reduction in fears about a 1930s-style crash in activity and the accompanying strong rebound in financial market sentiment might induce a larger-than-expected surge in consumption and investment across a number of advanced and emerging economies.
Extending the horizon to the medium term, there are other important risks to sustained recovery, mainly in the major advanced economies. On the financial front, a major concern is that continued public skepticism toward what is perceived as bailouts for the very firms considered responsible for the crisis undercuts public support for financial restructuring, thereby paving the way to a prolonged period of stagnation. On the macroeconomic policy front, the greatest risk revolves around deteriorating fiscal positions, including as a result of measures to support the financial sector.
Beyond 2010: Rebalancing the Global Economy
Achieving sustained healthy growth over the medium term will depend critically on addressing the supply disruptions generated by the crisis and rebalancing the global pattern of demand.
Lower Potential Output
Financial firms will need to be restructured and markets repaired to deliver adequate credit for sustained increases in investment and productivity, while labor will need to be redeployed across sectors. Historical evidence presented in Chapter 4 indicates that there were typically large, permanent hits to output in the aftermath of past financial crises, although the extent is difficult to determine and there have been a wide variety of outcomes. The current medium-term output projections are indeed on a much lower path than before the crisis, consistent with a permanent loss of potential output. Investment has already fallen sharply, especially in the economies hit by financial and real estate crises. Together with rising scrap rates, as corporations go bankrupt or restructure, this is reducing effective capital stocks. In addition, unemployment rates are expected to remain at high levels over the medium term in a number of advanced economies.
To complement efforts to repair the supply side of economies, there must also be adjustments in the pattern of global demand in order to sustain a strong recovery. Specifically, many economies that have followed export-led growth strategies and have run current account surpluses will need to rely more on domestic demand and imports. This will help offset subdued domestic demand in economies that have typically run current account deficits and have experienced asset price (stock or housing) busts, including the United States, the United Kingdom, parts of the euro area, and many emerging European economies. To accommodate the shifts on the demand side, there will need to be changes on the supply side as well. This will require action on many fronts, including measures to repair financial systems, improve corporate governance and financial intermediation, support public investment, and reform social safety nets to lower precautionary saving. Even with a strong commitment by all countries to reform along these and other lines, however, this process of rebalancing global demand will be a drawn-out process and will need to be supported by greater exchange rate flexibility.
The key policy priorities remain to restore the health of the financial sector and to maintain supportive macroeconomic policies until the recovery is on a firm footing, even though policymakers must also begin preparing for an eventual unwinding of extraordinary levels of public intervention. The premature withdrawal of stimulus seems the greater risk in the near term, but developing the medium-term macroeconomic strategy beyond the crisis is key for maintaining confidence in fiscal solvency and for price and financial stability. The challenge is to map a middle course between unwinding public interventions too early, which would jeopardize the progress made in securing financial stability and recovery, and leaving these measures in place too long, which carries the risk of distorting incentives and damaging public balance sheets.
Timing the Tightening of Accommodative Monetary Conditions
The key issues facing monetary policymakers are when to start tightening and how to unwind large central bank balance sheets. The two objectives do not necessarily present major conflicts, because instruments exist to start tightening monetary conditions even while balance sheets remain much larger than usual. The pace at which the buildup in central bank balance sheets should be unwound depends on progress in normalizing market conditions and the types of interventions in place.
Regarding the timing of monetary policy tightening, advanced and emerging economies face different challenges. In advanced economies, central banks can (with few exceptions) afford to maintain accommodative conditions for an extended period because inflation is likely to remain subdued as long as output gaps remain wide. Moreover, monetary policymakers will need to accommodate the impact of the gradual withdrawal of fiscal support. The situation is more varied across emerging economies; in a number of these economies it will likely be appropriate to start removing monetary accommodation sooner than in advanced economies. In some economies, warding off risks for new asset price bubbles may call for greater exchange rate flexibility, to allow monetary policy tightening to avoid importing an excessively easy policy stance from the advanced economies.
As the October 2009 GFSR emphasizes, continued central bank support will likely be needed through at least next year in many economies, and it could take much longer to unwind the buildup in illiquid assets on some central bank balance sheets. In the meantime, central banks have tools available to absorb reserves as needed to tighten monetary conditions. Looking beyond the short-term challenges, what are some lessons of the crisis for conducting monetary policy? Historical evidence suggests that relatively stable inflation and output growth offer little protection against major shocks to the economy from bursting asset price bubbles: output and inflation are poor predictors of asset price busts. Chapter 3 shows that other variables, notably credit growth and the current account balance, are better predictors and may deserve more attention from monetary policymakers. Thus, if concerns mount about domestic demand and asset prices, monetary policymakers should consider tightening more than required purely for the purpose of keeping inflation under control over the coming year or two. The chapter also argues that policymakers should consider complementing inflation targeting with the introduction of macroprudential tools to help stabilize economies. Macroprudential tools have the advantage of working directly to lean against credit cycles and can therefore be helpful in complementing the role of interest rates in stabilizing economies. Expectations of what can be achieved, however, need to be realistic.
Maintaining Fiscal Support while Safeguarding Fiscal Sustainability
Notwithstanding already large deficits and rising public debt in many countries, fiscal stimulus needs to be sustained until the recovery is on a firm footing and may need to be amplified or extended beyond current plans if downside risks to growth materialize. Governments should thus stand ready to roll out new initiatives as necessary. At the same time, they need to commit to large reductions in deficits once the recovery is on a solid footing and must start addressing long-term fiscal challenges by advancing reforms to put public finances on a more sustainable path. The achievement of such reductions could usefully be supported with more robust fiscal frameworks, including suitable fiscal rules and strong enforcement mechanisms. Such frameworks and rules can play helpful roles in reining in spending pressures when good times return, thereby providing a degree of reassurance to investors that deficits and debt eventually will be rolled back. This is essential to again create significant room for countercyclical policy and rebuild public support for financial markets, both of which will be needed to respond to future shocks.
Healing Financial Sectors while Reforming Prudential Frameworks
Completing financial sector repair and reforming prudential frameworks are indispensable for a return to sustained growth. Restructuring financial firms’ activities is key to a resumption of normal lending. As explained in more depth in the October 2009 GFSR, this will require balance sheet cleansing, recapitalization, and new business plans that are consistent with new funding models and new prudential frameworks. So far, there has been only very limited progress in removing impaired assets from bank balance sheets. The main challenge now is ongoing deterioration of asset quality. In this regard, official stress tests are important instruments through which the condition of banks can be diagnosed in order to design appropriate strategies for the recapitalization and restructuring of viable banks and for the careful resolution of nonviable banks. On this front, progress across countries has been uneven, and it is a source of concern that support for recapitalization faces political obstacles. Exit strategies need to be clearly articulated to help guide markets. Banks face a “wall of maturities” in the next two years, increasing rollover risks. In this setting, programs need to be phased out very gradually, using market-based incentives to encourage reduced reliance on public support.
Regarding fundamental reform, the achievement of a major overhaul must not be jeopardized by growing confidence that the greatest crisis dangers are past, fears that national competitive advantages might be lost, or concerns that first-best solutions are out of reach for technical reasons. As the October 2009 GFSR emphasizes, four challenges deserve particular attention. First, the perimeter of regulation needs to be broadened and made more flexible, covering all systemically important institutions alongside incentives to preclude further buildup of institutions currently considered “too big or too connected to fail.” Second, effective market discipline needs to be encouraged through greater transparency and disclosure and reform of governance in financial institutions. Third, macroprudential frameworks must induce banks to build more buffers—by raising capital and making provisions in good times that can be used in bad times. And, fourth, international collaboration and coordination need to be improved to adequately cope with the challenges posed by cross-border institutions.
Structural and Social Policy Challenges
Rising unemployment will present a major challenge in many advanced economies, and poverty will continue to challenge many developing economies. The evidence in Chapter 4 suggests that unemployment rates typically tend to rise significantly and remain higher for many years after financial shocks. Limiting the extent of job destruction will require slower wage growth or even wage cuts for many workers. The impact of the necessary adjustments on poorer segments of the labor force could be cushioned with earned income tax credits or similar programs that limit the social repercussions of wage adjustment. In addition, better job matching and education and training can help limit job and wage losses. Poverty could increase significantly in a number of developing economies, notably in sub-Saharan Africa, where real GDP per capita is contracting in 2009 for the first time in a decade. Continued donor support from advanced economies will be crucial if these economies are to sustain hard-won macroeconomic stability gains.