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IMFSurvey Magazine: IMF Research

World Economic Outlook

World Growth Grinds to Virtual Halt, IMF Urges Decisive Global Policy Response

IMF Survey online

January 28, 2009

  • IMF revises world growth down to lowest rate since World War II
  • Stresses need for stronger international policy response to the crisis
  • Banking sector must be unclogged to get economies moving again

World growth is forecast to fall to its lowest level since World War II, with financial markets remaining under stress and the global economy taking a sharp turn for the worse, sending both global output and trade plummeting, the IMF said in its latest assessment of the world economy.

"We now expect the global economy to come to a virtual halt," said IMF Chief Economist Olivier Blanchard in prepared remarks for a press briefing.

World growth is projected to fall to just ½ percent in 2009, its lowest rate in 60 years, the IMF said in an Update to its World Economic Outlook, released on January 28 together with an update to its Global Financial Stability Report. For projections, see table below.

Despite wide-ranging policy actions by governments and central banks around the world, financial strains remain acute, pulling down the real economy. The Update echoed comments by IMF Managing Director Dominique Strauss-Kahn that a sustained economic recovery will not be possible until the banking sector is restructured and credit markets are unclogged.

New policy initiatives needed

"For this purpose, new policy initiatives are needed to produce credible loan loss recognition; sort financial companies according to their medium-run viability; and provide public support to viable institutions by injecting capital, and carving out bad assets, including possibly through a "bad bank" approach," the Update stressed.

"We think that more decisive action is needed now by both policymakers and market participants, and with greater emphasis on balance sheet cleansing," said Jaime Caruana, Financial Counsellor of the IMF.

Caruana: Bank balance sheets need to be cleaned up to improve confidence

The IMF has raised its estimate of the potential deterioration in U.S. originated credit assets held by banks and others from $1.4 trillion last October to $2.2 trillion now [see related story].

Monetary and fiscal policies need to become even more supportive of aggregate demand and sustain this stance over the foreseeable future, while developing strategies to ensure long-term fiscal sustainability. Moreover, international cooperation will be critical in designing and implementing these policies in order to avoid destabilizing distortions.

Setbacks all round

Advanced economies will experience their sharpest contraction in the post-war period, the Update said. The IMF expects real activity to contract by around 1½ percent in the United States, 2 percent in the euro area, and 2½ percent in Japan.

• Though more resilient than in previous global downturns, emerging and developing economies will also suffer serious setbacks. For example, growth is expected to slow to 6¾ percent in China and 5 percent in India.

Global growth is projected to rebound in 2010 to 3.0 percent after falling sharply to just 0.5 percent in 2009, when measured in terms of purchasing power parity. The 2009 world growth forecast has been revised downward by 1.7 percent compared with the last IMF projection last November.

Falling world trade

The crisis in financial markets—which began in 2007 among subprime mortgages in the United States but has to spread to other markets and to much of the rest of the world—has resulted in a global recession that also continues to worsen.

Global output and trade fell sharply in the final months of 2008. The continuation of the financial crisis, with government policies failing to dispel uncertainty, has caused asset values to fall sharply across advanced and emerging economies, decreasing household wealth, and thereby putting downward pressure on consumer demand.

Blanchard: More aggressive and concerted actions are now needed."

In addition, the associated high level of uncertainty has prompted households and businesses to postpone expenditures, reducing demand for consumer and capital goods. At the same time, widespread disruptions in credit are constraining household spending and curtailing production and trade.

The IMF has so far committed $47.9 billion in lending to a number of economies affected by the crisis, including Belarus, Hungary, Iceland, Latvia, Pakistan, Serbia, and Ukraine. It announced a precautionary loan for El Salvador this month and an IMF team is also in negotiations with Turkey.

Creating a turnaround

Blanchard emphasized that two types of measures are needed to turn things around:

1. Stronger policy actions to restore financial sector health. Reviving the functioning of the financial sector and unclogging credit markets is a necessary condition for economic recovery. The building blocks of what needs to be done have been assembled to varying degrees in many countries, but a comprehensive framework for restoring financial health and dealing with bad assets remains to be built, and the financial crisis has lingered. More aggressive and concerted actions are now needed—through a unified approach involving liquidity provision, capital injections, and disposal of problem assets.

2. Macroeconomic stimulusboth monetary and fiscalto support demand.

On monetary policy, many central banks have taken strong actions to cut interest rates and improve credit provision. The IMF still sees some room to lower interest rates, as inflation pressures are subsiding, but the room is diminishing rapidly, and has disappeared altogether in some countries. Moreover, deflation is now a risk. In present circumstances, the effectiveness of low interest rates to support activity is likely to be constrained as long as financial conditions remain disrupted. Therefore, central banks will need to rely increasingly on unconventional measures to unlock key (high-spread, low-liquidity) credit markets.

On fiscal policy, many countries have announced and are already implementing sizeable stimulus. The key here is to design packages that provide maximum boost to demand, which argues for measures to increase spending. However, fiscal deficits are widening sharply because of the cyclical downturn and the impact of asset price declines on revenues, as well as stimulus measures and the cost of financial sector rescues. To prevent an adverse market reaction, the IMF says policymakers need to strengthen fiscal frameworks and commit to credible longer-term policies that reverse the deficit buildup as economies recover.

Space for easing

Blanchard also stressed that there is no "one-size-fits-all" policy mix. Some countries have more fiscal and monetary space than others. "In this respect, it is welcome that some emerging economies now have more space for policy easing than in previous downturns and are making use of it," he said.

However, many emerging and developing countries are facing a need to adjust to permanent adverse shocks in access to external financing and terms of trade. While the use of reserves and IMF financing can help smooth the transition, these countries may also need to rein in spending and improve external competitiveness.

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


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