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IMFSurvey Magazine: IMF Research

WORLD ECONOMIC OUTLOOK

Financial Crisis Likely to Worsen Economic Downturn

IMF Survey online

October 2, 2008

  • IMF publishes new research on shocks to world economy
  • Main outlook on global economy to be published on October 8
  • U.S. financial crisis likely to weigh hard on real economy

The current financial market meltdown being witnessed in the United States and other advanced economies will likely lead to longer and deeper economic downturns in some of these countries, according to new IMF research.

An analytic chapter published in the October 2008 World Economic Outlook (WEO) examines the impact of the financial shocks on the world economy.

"Economies like the United States, with more arms-length or market-based financial systems, seem to be particularly vulnerable to sharp contractions in activity in the face of financial stress," Charles Collyns, Deputy Director in the IMF's Research Department, said at a press briefing today. Citing the chapter, "Financial Stress and Economic Downturns," he added that "this is because leverage tends to be more procyclical in these economies, which means that when a shock hits the financial system, the process of deleveraging can be more severe, and the risks of a credit crunch are greater."

However, other factors also play a role in determining the impact of financial stress on the economy. In the case of the United States, the research notes, the health of the nonfinancial corporate sector and the timely and decisive reaction of the Federal Reserve in lowering interest rates have so far helped the country avoid slipping into a recession.

Main WEO forecast

The main forecasting chapters of the World Economic Outlook (WEO) will be released on October 8, two days prior to the IMF-World Bank Annual Meetings in Washington, D.C. The meetings, which bring together finance ministers and other leading economic and financial experts from all over the world, will take on a special significance this year—being conducted amid a global financial crisis of unprecedented scale and depth.

WEO analytic chapters

In addition to the chapter on financial stress and economic downturns, the other WEO analytic chapters examine the question of whether inflation continues to be a threat at a time when commodity prices have seen declines from their historical peaks; the value of fiscal policy as a countercyclical tool; and the divergent patterns of current account balances across a sample of emerging economies in Asia and Europe.

Click here to read short accounts of all four analytic chapters:

Chapter 3: Inflation Risks Remain Despite Slowing Growth
Commodity prices will likely remain high and volatile, contributing to risks of second-round effects—such as wage hikes—across a range of emerging and developing economies, and further monetary policy tightening may be still relevant to contain these inflationary pressures, according to new IMF research.

Chapter 4: Financial Stress Likely to Hit Real Economy Hard
Episodes of financial turmoil that are characterized by stress in commercial and investment banks are more likely to be associated with severe and protracted economic downturns, according to new IMF research.

Chapter 5: Making Fiscal Stimulus Effective during Downturns
A new IMF study finds that although fiscal policy is a potentially valuable tool for stimulating growth, it can easily do more harm than good if it is not implemented well. Tax cuts or spending increases that make debt unsustainable are likely to cause output to fall, not rise.

Chapter 6: Lessons from Cross-Regional Analysis
A new IMF study explores the patterns of current account balances of emerging economies—especially in emerging Asia and emerging Europe—and asks why they have become much more diverse in recent years and what those differences mean for external vulnerability in these regions.

Comments on this article should be sent to imfsurvey@imf.org


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