Group of Twenty
IMF Note to the Group of Twenty Deputies — Executive Summary
February 5, 2009
About the Executive Summary
The global economy is in the midst of a deep downturn, as an adverse feedback loop between the real and financial sectors is taking its toll. The dramatic worsening of the financial crisis since mid-September has generated historic declines in confidence and severe disruptions in credit intermediation. The precipitous decline in activity across the globe is in turn further damaging the financial sector.
Wide-ranging policy actions have helped avert a global financial meltdown. But systemic risks are at elevated levels and credit conditions remain seriously impaired, as financial losses continue to mount. In the advanced economies, heavy pressure to delever will continue, while financial pressures will remain acute for emerging economies, notably for corporates facing large rollover requirements.
Global growth is expected to decline sharply from 3½ percent in 2008 to ½ percent in 2009 —the lowest increase since World War II—before recovering gradually to around 3 percent in 2010. This turnaround depends critically on more effectively addressing financial problems while sustaining strong policy support for domestic demand. Advanced economies will experience their sharpest contraction in the post-war period. Emerging and developing economies in the aggregate would be more resilient than in previous global downturns, but some economies will suffer serious setbacks.
Downside risks to the outlook remain substantial . The overarching risk revolves around the possibility of further corrosive interaction between more severe contraction in global economic activity and even greater and more prolonged financial strains than currently envisaged, particularly if policy implementation falls short.
Policy actions to resolve the financial crisis have been broad in scope, but have not yet achieved a decisive breakthrough . While there are pockets of improvement in some markets where policy intervention has taken place, financial markets remain under heavy strain and systemic institutions are still perceived as fragile. Challenges persist across a wide range of markets and instruments.
Conventional monetary easing has had a limited impact on financial conditions and in normalizing credit intermediation, necessitating direct intervention in credit markets . This has led to a rapid expansion of public balance sheets, including those of central banks. Fiscal policy is providing important support to the economy through a range of channels. While such support is critical to bolster aggregate demand and to limit the impact of the financial crisis on the real economy, it implies a significant deterioration in the fiscal accounts.
More aggressive and concerted policy actions are urgently needed to resolve the crisis and establish a durable turnaround in global activity . To be effective, policies need to be comprehensive and internationally coordinated to limit unintended cross-border effects. Action is needed on two fronts—to restore financial sectors to health and to bolster demand to sustain a durable recovery in global activity.
Restoring financial health will require a three-pronged approach, involving the continued provision of ample liquidity and term funding support from central banks, dealing promptly and aggressively with distressed assets, and recapitalizing viable institutions with public funds . Immediate, short-run policies and actions taken need to be consistent with the long-run vision for the structure of a viable financial system and with medium-term fiscal sustainability. If the financial sector is not restored to health, an enduring recovery will not be possible.
Various approaches may be used to resolve distress assets, tailored to individual institution and country circumstances . Cleaning bank balance sheets—including through a transparent process for valuing distressed assets and putting a ceiling on losses—will be critical to restore confidence in financial institutions and reduce counterparty risk. An approach that would ensure maximum transparency and greatly reduce uncertainty, although entailing high upfront fiscal costs, would be to transfer the assets to a "bad" bank. Such an approach has been tried and tested in previous crises and has yielded generally favorable outcomes.
Recapitalization using public balance sheets should make a clear differentiation between viable and non-viable institutions to enable greater consolidation in the financial sector. Most critically, recapitalization must be of a sufficient size to decisively address solvency concerns, especially by ensuring that it is resilient to further deterioration in bank balance sheets as a result of the worsening macroeconomic environment.
International cooperation on a coherent set of financial policies should receive high priority. The application of substantially different conditions when supporting financial institutions should be avoided in order to prevent unintended consequences that may arise from competitive distortions and regulatory arbitrage. International coordination is also needed to avoid excessive "national bias" to the detriment of other countries.
Macroeconomic policy stimulus will be critical to support demand while financial issues are addressed and to avoid a deep and prolonged recession . With conventional monetary policy reaching its limits, central banks will need to explore alternative policy approaches with a focus on intervention to unlock key credit markets. That said, with constraints on the effectiveness of monetary policy, fiscal policy must play a central role in supporting demand, while remaining consistent with medium-term sustainability. A key feature of a fiscal stimulus program is that it should support demand for a prolonged period of time and be applied broadly across countries with policy space to minimize cross-border leakages.
Policymakers need to be mindful of the importance of maintaining confidence in medium-term fiscal sustainability . Stimulus measures must be accompanied by credible steps to strengthen medium-term fiscal prospects. Fiscal packages should rely on temporary measures and policies should be formulated within credible medium-term fiscal frameworks. These frameworks should entail gradual fiscal corrections as conditions improve. Countries facing forthcoming demographic challenges—particularly faster aging—should have a clear plan for reform of health and pension entitlements.