## World Economic Outlook: A Rocky Recovery (April 2023) — Selected Chapter Excerpts

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### Key projections and macroeconomic outlook
- Global growth:
  - Global growth will bottom out at 2.8 percent in 2023 before rising to 3.0 percent in 2024.
  - Global growth was estimated at 3.4 percent in 2022 and is forecast to fall to 2.8 percent in 2023, before rising to 3.0 percent in 2024.
  - Baseline projection: global growth slows from "2.7 percent in 2022 to 1.3 percent in 2023." (alternative phrasing in chapter.)
- Inflation:
  - Global inflation: 8.7 percent in 2022; projected 7.0 percent in 2023; 4.9 percent in 2024.
  - Core inflation (excluding energy and food): expected to decline to 5.1 percent in 2023 (fourth quarter over fourth quarter).
  - For 72 inflation-targeting economies (34 advanced, 38 major EMDEs):
    - Annual average inflation will exceed targets in 97 percent of cases in 2023.
    - Median deviation from target in 2023: 3.3 percentage points.
    - By 2025, median deviation from target expected to be 0.2 percentage point.
- Selected country and group headline projections (percent change):
  - World Output: 2022 = 3.4; 2023 = 2.8; 2024 = 3.0.
  - Advanced Economies: 2022 = 2.7; 2023 = 1.3; 2024 = 1.4.
  - United States: 2022 = 2.1; 2023 = 1.6; 2024 = 1.1.
  - Euro Area: 2022 = 3.5; 2023 = 0.8; 2024 = 1.4.
  - Emerging Market and Developing Economies: 2022 = 4.0; 2023 = 3.9; 2024 = 4.2.
  - China: 2022 = 3.0; 2023 = 5.2; 2024 = 4.5.
  - India: 2022 = 6.8; 2023 = 5.9; 2024 = 6.3.
- Fourth quarter over fourth quarter growth highlights:
  - Emerging market and developing economies: from 2.8 percent in 2022 to 4.5 percent in 2023.
  - Euro area: 0.7 percent in 2023 and 1.8 percent in 2024.
  - United Kingdom: –0.4 percent in 2023 and 2.0 percent in 2024.
- Projections based on data through March 28, 2023.

### Risks, downside scenarios, and probabilities
- Overall bias and key probabilities:
  - Overall risk bias: squarely to the downside.
  - Probability of global growth in 2023 falling below 2.0 percent: about 25 percent.
  - Probability of a contraction in global per capita real GDP in 2023: about 15 percent.
  - Probability of global headline inflation exceeding its 2022 level in 2023: less than 10 percent.
  - Probability for core inflation exceeding its 2022 level in 2023: 30 percent.
- Severe downside scenario (financial sector stress; Box 1.3 layered shocks):
  - Combined effect implies a decrease in the level of global output of 1.8 percent in 2023 and 1.4 percent in 2024, relative to the baseline.
  - Credit conditions layer: bank lending in the United States decreases by 4 percent in 2023 relative to baseline; corporate spreads increase by 250 basis points in 2023.
  - Equity prices: global equity prices fall by 10 percent on impact and by about 6 percent on average in 2023.
  - Dollar appreciation and sovereign premia: US dollar appreciates by close to 10 percent in emerging markets excluding Asia; substantial sovereign premium increases.
  - Disinflationary impulse in scenario: global core inflation declines by 0.9 percentage point in 2023 and by 1.1 percentage points in 2024, relative to baseline.
  - Policy rates decline in the scenario: US policy rates decline by 1.6 percentage points in 2023 and 1.8 percentage points in 2024 relative to baseline; global average policy rates decline by 2.1 and 2.3 percentage points in 2023 and 2024, respectively.
- Plausible alternative scenario (moderate additional tightening):
  - Implied real growth: about 2.5 percent in 2023 instead of 2.8 percent in baseline.
  - Real GDP effects (percent deviations from baseline): World decreases by 0.3 percent in 2023; 0.2 percent lower in 2024.
  - United States, euro area, and Japan: about 0.4 percentage point lower growth in 2023 versus baseline.
- Other downside channels emphasized:
  - Sharper monetary policy impact amid high debt, stickier inflation, systemic sovereign debt distress (about 56 percent of low-income developing countries estimated to be either already in debt distress or at high risk), faltering growth in China, escalation of the war in Ukraine, and geoeconomic fragmentation.

### Policy implications — monetary, fiscal, financial sector
- Monetary policy:
  - Central banks should remain firmly focused on bringing inflation down, staying steady with a tighter anti-inflation stance while remaining ready to use the full set of instruments as developments demand.
  - If financial stability is at stake in a severe scenario, substantial readjustment of monetary policy paths might be needed to contain contagion and minimize economic damage.
  - Once inflation returns to target, low or declining natural rates may constrain central banks; unconventional tools (balance sheet policy, forward guidance) may be needed.
- Fiscal policy:
  - Tighter fiscal policy can support disinflation and rebuild fiscal buffers; appropriately designed consolidations help strengthen financial stability.
  - In most cases, aim for an overall tight stance while providing targeted support to those most affected by the cost-of-living crisis; in a severe downside scenario, allow automatic stabilizers to operate fully and use temporary support as fiscal space permits.
  - Debt sustainability: medium-term consolidation and, where necessary, debt restructuring.
- Financial sector policies:
  - Regulators/supervisors should intensify monitoring, deploy targeted liquidity-support tools when needed (properly collateralized, preserving monetary transmission), and strengthen oversight—including nonbank financial institutions.
  - Use of the global financial safety net: IMF precautionary arrangements, rechanneling SDRs, PRGT and RST support, and access to swap lines or Fed repo facilities where relevant.
- Exchange rates and capital flows:
  - Currencies should be allowed to adjust to fundamentals unless doing so threatens price or financial stability; temporary capital flow management measures on outflows may be warranted in crisis situations.

### Public debt: drivers, restructuring, and policy guidance (Chapter 3)
- Debt context and trends:
  - Public debt ratio approached 100 percent in 2020 and remains above pre-pandemic levels for about half of the world.
  - Private and public debt reached levels not seen in decades in most economies.
- Effectiveness of fiscal consolidation:
  - The average size of primary balance consolidations that reduced debt ratios in the past is about 0.4 percentage point of GDP.
  - Such consolidations lowered the average debt ratio by 0.7 percentage point in the first year and up to 2.1 percentage points after five years.
  - Baseline probability of success for consolidations: about 50 percent; conditional probability of success can exceed 75 percent under favorable conditions.
- Restructuring impacts and stylized facts:
  - Restructurings reduce debt ratios more sharply when they involve face value reductions and when part of coordinated large-scale initiatives (HIPC, MDRI).
  - AIPW estimator main results: average debt ratios decrease by 3.4 percentage points in the first year and 8 percentage points within five years of restructuring (EMs and LICs sample).
  - Table 3.4 sample statistics (1950–2021; 709 events across 115 countries): cash flow relief without face value reduction: Emerging Market Economies 85.8; Low-Income Countries 73.5. Face value reduction: Emerging Market Economies 14.2; Low-Income Countries 26.5.
- Decomposition and drivers during reduction episodes:
  - On average, a debt reduction episode lasts five years.
  - Magnitude of annual decline in debt ratio: about 3 percentage points in advanced economies, 5 percentage points in emerging market economies, and 10 percentage points in low-income countries.
  - Primary balance surpluses and real GDP growth are key drivers; nominal interest expense contributes positively to debt changes.
- Policy recommendations for debt sustainability:
  - When feasible, pursue well-timed, growth-friendly consolidations, paired with structural reforms and strong institutions.
  - For countries with high distress risk, consider timely debt restructuring that is deep and coordinated, combined with fiscal consolidation and growth policies.
  - Improve creditor coordination mechanisms (G20 Common Framework enhancements) and debt transparency.
  - Avoid using high inflation as a deliberate debt-reduction tool.

### The natural rate of interest — drivers, outlook, and policy implications (Chapter 2)
- Definition and role:
  - Natural rate of interest (r*): the real interest rate neither stimulatory nor contractionary, consistent with output at potential and stable inflation.
- Historical trend and drivers:
  - Real rates have fallen by about 5 percentage points over the last four decades across maturities in advanced economies.
  - Main common drivers: demographic changes (population aging) and productivity slowdowns; international spillovers and demand for safe assets also mattered.
- Measurement and models:
  - Two-pronged empirical approach: Laubach-Williams (HLW) Kalman-filter estimates and a structural PP model (Platzer and Peruffo 2022).
  - Results broadly consistent: natural rate declined across advanced economies by a little over 2 percentage points in many cases; uncertainty large (90 percent confidence intervals can span zero to about 3 percent for the US in recent vintages).
- Outlook and scenarios:
  - Baseline: natural rates likely to stay close to pre-pandemic levels in advanced economies; significant declines projected in many emerging markets as demographics and productivity evolve.
  - Example: China projected to see about a 1.5 percentage point decline in the natural rate within the next 30 years, bringing it to about zero in 2050 under baseline assumptions.
  - Alternative scenarios span about 120 basis points around baseline, with illustrative effects:
    - Erosion of convenience yield reversal could raise advanced-economy natural rates by about 70 basis points.
    - Reversal of large foreign portfolio investments could raise the US natural rate by roughly 100 basis points by 2050.
    - Energy-transition scenarios: r* may decline by 50 basis points by 2050 under budget-neutral transition; temporary deficit-financed green investment could raise r* by about 30 basis points.
- Policy implications:
  - Low long-term r* limits room for conventional monetary easing (effective lower bound concerns); central banks may rely more on balance sheet policies and forward guidance.
  - Fiscal policy has an expanded role in stabilization, but debt sustainability remains critical; borrowing costs’ sensitivity to debt requires robust fiscal frameworks.

### Geoeconomic fragmentation and foreign direct investment (Chapter 4)
- Key observations:
  - Global FDI (greenfield) declined in the post-pandemic period (2020:Q2 to 2022:Q4) by almost 20 percent compared to the pre-pandemic post–global financial crisis average.
  - Strategic FDI to Asia started declining in 2019 and recovered only mildly; by 2022:Q4 strategic FDI to Europe was about twice that going to Asian countries.
  - Bilateral FDI increasingly concentrated among geopolitically aligned partners; an increase in ideal point distance from the first to the third quartile is associated with a decline in FDI of about 17 percent.
- Vulnerability index and distribution:
  - Multidimensional vulnerability index combines geopolitical distance, market power (top-10 exporter status), and share of strategic-sector investment.
  - On average, EMDEs are more vulnerable to FDI relocation than advanced economies.
  - Better regulatory quality is associated with lower aggregate vulnerability (coefficient of –0.057; p-value = 0.000 in binned scatterplot regression controlling for log real GDP, trade, and FDI inflows).
- Spillovers and firm-level evidence:
  - Vertical FDI associated with growth and knowledge transfer; vertical FDI is more exposed to fragmentation than horizontal FDI.
  - World Bank Enterprise Surveys (>120,000 firms): positive within-industry productivity spillovers concentrated in advanced economies; positive cross-industry supplier spillovers driven by FDI in EMDEs.
- Model-based quantification and scenarios:
  - Multiregion DSGE scenarios: a permanent rise in cross-bloc investment barriers could reduce global output by about 2 percent in the long term; benchmark decoupling scenario yields global output about 1 percent lower after five years and 2 percent lower in the long term.
  - Nonaligned regions face tradeoffs: diversion of investment inputs can help if substitution elasticities are high; policy uncertainty amplifies losses for nonaligned regions.
- Policy recommendations:
  - Preserve multilateral dialogue and consultations to reduce uncertainty and costs of fragmentation.
  - Improve domestic regulatory quality and promote private sector development to reduce vulnerability to FDI relocation.
  - Carefully weigh strategic reshoring and friend-shoring objectives against economic costs and third-party spillovers.

### Commodity markets, energy transition, and extraction declines
- Commodity developments (August 2022 – February 2023):
  - Primary commodity prices declined 28.2 percent between August 2022 and February 2023.
  - Energy commodities down 46.4 percent; European natural gas prices down 76.1 percent; crude oil retreated 15.7 percent over the period.
  - Futures imply crude oil averaging $73.1 a barrel in 2023 (from $96.4 in 2022) and falling to $65.4 in 2026.
- Macroeconomic impact of persistent declines in fossil fuel extraction (empirical episodes):
  - Representative episode: 10 percent contraction in extraction in year one, cumulating to 40 percent reduction over 10 years.
  - Estimated effects of a typical extraction-decline episode:
    - Real GDP falls by 1 percent initially and cumulates to 5 percent after five years (persistent with no rebound through the horizon).
    - Real exchange rate depreciates slowly by 20 percent.
    - Exports decline about 6 percent; manufacturing and services value added fall about 5 percent.
    - Aggregate consumption responds with a lag of more than five years.
  - Heterogeneity: institutional quality and initial manufacturing share matter; middle- and low-income countries suffer larger GDP impacts than high-income countries.
- Policy recommendations for energy-transition adjustment:
  - Improve public finances and institutional quality; diversify economies; set up sovereign wealth funds; facilitate reallocation of production factors.
  - Invest in human capital, infrastructure, and measures to attract FDI and R&D.
  - Clarify global and national climate-policy direction to reduce adjustment uncertainty.

### Data assumptions, conventions, and statistical notes
- Key assumptions for projections and conventions:
  - Real effective exchange rates assumed constant at average during February 15, 2023–March 15, 2023 (except ERM II participants: constant in nominal terms relative to the euro).
  - Established policies of national authorities assumed maintained.
  - Oil price assumption: $73.13 a barrel in 2023; $68.90 a barrel in 2024.
  - Short-term (three-month) government bond yields assumed:
    - United States: 5.1 percent in 2023 and 4.5 percent in 2024.
    - Euro area: 2.8 percent in 2023 and 3.0 percent in 2024.
    - Japan: −0.1 percent in 2023 and 0.0 percent in 2024.
  - Ten-year government bond yield assumptions:
    - United States: 3.8 percent in 2023 and 3.6 percent in 2024.
    - Euro area: 2.5 percent in 2023 and 2.8 percent in 2024.
    - Japan: 0.6 percent in 2023 and 0.6 percent in 2024.
- Data conventions:
  - “Billion” means a thousand million; “trillion” means a thousand billion.
  - Basis points refer to hundredths of 1 percentage point (for example, 25 basis points = ¼ of 1 percentage point).
  - Composite country-group calculations are based on 90 percent or more of weighted group data unless noted otherwise.
  - WEO data and projections compiled by IMF staff “as is” and “as available.”
- Coverage and updates:
  - WEO database: 196 economies.
  - Data and projections compiled through March 28, 2023; Statistical Appendix provides detailed conventions, country notes, and what’s new.

*Source: International Monetary Fund — World Economic Outlook: A Rocky Recovery (April 2023), Preface and Chapters 1–4, Statistical Appendix excerpts.*

### Preface                                                                                                                 

### Preface

### Contents overview
- Executive Summary
- Chapter 1. Global Prospects and Policies
  - A Rocky Recovery
  - A Challenging Outlook
  - Downside Risks Dominate
  - Policy Priorities: Walking a Narrow Path
  - Box 1.1. House Prices: Coming off the Boil
  - Box 1.2. Monetary Policy: Speed of Transmission, Heterogeneity, and Asymmetries
  - Box 1.3. Risk Assessment Surrounding the World Economic Outlook Baseline Projections
  - Commodity Special Feature: Market Developments and the Macroeconomic Impact of Declines in Fossil Fuel Extraction
- Chapter 2. The Natural Rate of Interest: Drivers and Implications for Policy
  - Introduction
  - Trends in Real Rates over the Long Term
  - Measuring the Natural Rate
  - Drivers of the Natural Rate
  - The Outlook for the Natural Rate
  - Policy Implications
  - Box 2.1. The Natural Rate of Interest and the Green Transition
  - Box 2.2. Geoeconomic Fragmentation and the Natural Interest Rate
  - Box 2.3. Spillovers to Emerging Market and Developing Economies
- Chapter 3. Coming Down to Earth: How to Tackle Soaring Public Debt
  - Introduction
  - Macroeconomic Drivers of the Debt-to-GDP Ratio
  - Debt Restructuring and Its Effects
  - Going Granular: Case Studies of Debt Restructuring
  - Conclusions and Policy Implications
  - Box 3.1. Market Reforms to Promote Growth and Debt Sustainability
  - Box 3.2. Monetary and Fiscal Interactions
- Chapter 4. Geoeconomic Fragmentation and Foreign Direct Investment
  - Introduction
  - Early Signs of FDI Fragmentation
  - Which Host Countries Are More Vulnerable to FDI Relocation?
  - FDI Spillovers to Host Countries
  - A Model-Based Quantification of the Costs of FDI Fragmentation
  - Policy Implications
  - Box 4.1. Rising Trade Tensions
  - Box 4.2. Balance Sheet Exposure to Fragmentation Risk
  - Box 4.3. Geopolitical Tensions, Supply Chains, and Trade
- Statistical Appendix, Assumptions, What’s New, Data and Conventions, Country Notes, Classification of Countries
- Tables, Figures, and Online Tables covering projections, indicators, and scenario analyses (detailed listings in the Preface)

### Key assumptions and conventions (as stated)
- Real effective exchange rates are assumed to have remained constant at their average levels during February 15, 2023, to March 15, 2023, except for currencies participating in the European exchange rate mechanism II, which are assumed to have remained constant in nominal terms relative to the euro.
- Established policies of national authorities are assumed to be maintained (for specific assumptions about fiscal and monetary policies for selected economies, see Box A1 in the Statistical Appendix).
- The average price of oil is assumed to be $73.13 a barrel in 2023 and $68.90 a barrel in 2024.
- The three-month government bond yield for the United States will average

*Source: Preface, World Economic Outlook: A Rocky Recovery (April 2023), International Monetary Fund — text provided in the Preface section of the WEO PDF.*

### 5.1 percent in 2023 and 4.5 percent in 2024, that for the euro area will average 2.8 percent in 2023 and 3.0

### WORLD ECONOMIC OUTLOOK: A ROCKY RECOVERY

### Key projections and macroeconomic outlook
- Global growth will bottom out at 2.8 percent in 2023 before rising to 3.0 percent in 2024.
- Global inflation is projected to decline from 8.7 percent in 2022 to 7.0 percent in 2023 and 4.9 percent in 2024.
- Fourth quarter over fourth quarter growth:
  - Emerging market and developing economies: from 2.8 percent in 2022 to 4.5 percent in 2023.
  - Euro area: 0.7 percent in 2023 and 1.8 percent in 2024.
  - United Kingdom: –0.4 percent in 2023 and 2.0 percent in 2024.
- Core inflation (excluding energy and food) is expected to decline to 5.1 percent in 2023 (fourth quarter over fourth quarter), representing an upward revision of 0.6 percentage point from the January update.
- Five-year-ahead growth forecasts declined from 4.6 percent in 2011 to 3.0 percent in 2023.

### Specific working hypotheses for major economies and yields (stated as working hypotheses rather than forecasts)
- Real activity:
  - United States growth: 5.1 percent in 2023 and 4.5 percent in 2024.
  - Euro area growth: 2.8 percent in 2023 and 3.0 percent in 2024.
  - Japan growth: –0.1 percent in 2023 and 0.0 percent in 2024.
- Ten-year government bond yields:
  - United States: 3.8 percent in 2023 and 3.6 percent in 2024.
  - Euro area: 2.5 percent in 2023 and 2.8 percent in 2024.
  - Japan: 0.6 percent in 2023 and 0.6 percent in 2024.
- Estimates and projections are based on statistical information available through March 28, 2023.

### Risks, vulnerabilities, and downside scenarios
- Financial-sector side effects from rapid policy tightening include sizable losses on long-term fixed-income assets and increased vulnerabilities among banks and nonbank financial institutions.
- Recent examples of strain:
  - Gilt market stress in the United Kingdom (autumn prior to April 2023).
  - Banking turbulence in the United States with the collapse of a few regional banks.
- Severe downside scenario:
  - A sharp tightening of global financial conditions—“risk-off” shock—could cause large capital outflows, a sudden increase in risk premia, a dollar appreciation, and major declines in global activity.
  - In such a severe downside scenario, global GDP per capita could come close to falling, an outcome whose probability is estimated at about 15 percent.
- Structural and medium-term risks:
  - Slower five-year-ahead growth reflects the growth slowdown of previously rapidly growing economies such as China and Korea, the scarring impact of the pandemic, a slower pace of structural reforms, rising geoeconomic fragmentation, more trade tensions, less direct investment, and a slower pace of innovation and technology adoption across fragmented ‘blocs’.

### Policy implications and recommendations
- Monetary policy:
  - As long as the financial system remains reasonably stable, monetary policy should stay firmly focused on bringing inflation down.
  - The banking turmoil may help slow aggregate activity as banks curtail lending, which could partially mitigate the need for further monetary policy tightening.
  - Any expectation that central banks will abandon the fight against inflation would lower yields, support activity beyond what is warranted, and complicate the task of central banks.
- Fiscal policy:
  - Tighter fiscal policy can play an active role by cooling off economic activity and supporting monetary policy, allowing real interest rates to return faster to their low natural level.
  - Appropriately designed fiscal consolidations will help rebuild fiscal buffers and strengthen financial stability.
- Financial sector policies:
  - Regulators and supervisors should act now to prevent market strains from morphing into a full-blown financial crisis by actively managing market strains and strengthening oversight.
  - For emerging market and developing economies, ensure proper access to the global financial safety net, including the IMF’s precautionary arrangements, and access to the Federal Reserve repurchase facility for Foreign and International Monetary Authorities or to central bank swap lines, where relevant.
  - Exchange rates should adjust as much as possible unless doing so raises financial stability risks or threatens price stability, in line with the Integrated Policy Framework.
- Crisis contingency:
  - Should a systemic financial crisis loom, a careful and timely recalibration of policy will be needed to safeguard both the financial system and economic activity.

### Data conventions, scope, and publication notes
- Conventions used throughout the WEO:
  - . . . to indicate that data are not available or not applicable.
  - – between years or months (for example, 2022–23 or January–June) to indicate the years or months covered, including the beginning and ending years or months.
  - / between years or months (for example, 2022/23) to indicate a fiscal or financial year.
  - “Billion” means a thousand million; “trillion” means a thousand billion.
  - “Basis points” refers to hundredths of 1 percentage point (for example, 25 basis points are equivalent to ¼ of 1 percentage point).
- Data refer to calendar years, except for a few countries that use fiscal years; see Table F in the Statistical Appendix for exceptions.
- For some countries, figures for 2022 and earlier are based on estimates rather than actual outturns; see Table G in the Statistical Appendix for the latest actual outturns.
- Composite country-group calculations are based on 90 percent or more of the weighted group data unless noted otherwise.
- The WEO data and projections are compiled by IMF staff and are “as is” and “as available”; corrections and revisions based on subsequently discovered errors are incorporated into the digital editions available from the IMF eLibrary and IMF website.

*International Monetary Fund | April 2023*

### 2.7 percent in 2022 to 1.3 percent in 2023. In a plau-

### GLOBAL PROSPECTS AND POLICIES — A Rocky Recovery

### Outlook and scenarios
- Baseline projection: global growth slows from "2.7 percent in 2022 to 1.3 percent in 2023."
- Plausible alternative (with further financial sector stress): global growth declines to "about 2.5 percent in 2023" — characterized as "the weakest growth since the global downturn of 2001, barring the initial COVID-19 crisis in 2020 and during the global financial crisis in 2009" — with advanced economy growth "falling below 1 percent."
- Key drivers of the anemic outlook: tight policy stances to reduce inflation, fallout from recent deterioration in financial conditions, the ongoing war in Ukraine, and growing geoeconomic fragmentation.
- Risks are "heavily skewed to the downside," with the chances of a hard landing having "risen sharply."

### Inflation, monetary policy, and inflation persistence
- Global headline inflation is set to fall "from 8.7 percent in 2022 to 7.0 percent in 2023" on the back of lower commodity prices.
- Underlying (core) inflation is "likely to decline more slowly."
- "Inflation’s return to target is unlikely before 2025 in most cases."
- Major central banks have been raising interest rates since 2021, "both at a faster pace and in a more synchronous manner" than in the pre-global financial crisis tightening episode.
- Market and central bank signals have diverged at times: markets anticipated less tightening than central banks, prompting repricing episodes (notably in the United States), and recent financial-sector turbulence has reopened gaps between market-implied policy paths and central bank communications.
- Headline inflation examples across economies:
  - Euro area: "nearly 7 percent (year over year)" with "some member states seeing rates near 15 percent."
  - United Kingdom: "above 10 percent."

### Financial sector stress, labor markets, and real economy risks
- Recent financial developments:
  - Failures of two specialized regional banks in the United States (mid-March 2023) and the collapse of confidence in Credit Suisse culminated in a brokered takeover.
  - Broad equity indices fell below pre-turmoil levels; bank equities faced "extreme pressure."
  - Financial conditions have tightened and "are likely to entail lower lending and activity if they persist."
- Contagion and amplification risks:
  - Financial sector stress could amplify and contagion could weaken the real economy via a sharp deterioration in financing conditions, potentially forcing central banks to reconsider policy paths.
  - "Pockets of sovereign debt distress could, in the context of higher borrowing costs and lower growth, spread and become more systemic."
  - The war in Ukraine could intensify and lead to more food and energy price spikes, pushing inflation up.
  - Core inflation could prove more persistent than anticipated, requiring additional monetary tightening.
  - "Fragmentation into geopolitical blocs has the scope to generate large output losses, including through its effects on foreign direct investment."
- Labor market conditions:
  - Labor markets in advanced economies—"most notably, the United States"—have stayed "very strong, with unemployment rates historically low."
  - Labor market tightness partly reflects a slow post-pandemic recovery in labor supply, including "fewer older workers participating in the labor force."
  - The ratios of job openings to the number of people unemployed in the United States and the euro area at "the end of 2022 were at their highest levels in decades."
  - So far, wage pressures have remained contained and "real wage growth in advanced economies has been lower than it was at the end of 2021."

### Policy recommendations and priorities
- Monetary policy:
  - Central banks should "remain steady with their tighter anti-inflation stance," but be ready to adjust and "use their full set of policy instruments—including to address financial stability concerns—as developments demand."
- Fiscal policy:
  - Fiscal policymakers should "buttress monetary and financial policymakers’ actions in getting inflation back to target while maintaining financial stability."
  - In most cases, governments "should aim for an overall tight stance while providing targeted support to those struggling most with the cost-of-living crisis."
  - In "a severe downside scenario," automatic stabilizers should be "allowed to operate fully and temporary support measures be utilized as needed, fiscal space permitting."
  - "Medium-term debt sustainability will require well-timed fiscal consolidation but also debt restructuring in some cases."
- Exchange rates and capital flows:
  - "Currencies should be allowed to adjust to changing fundamentals," but deploying capital flow management policies on outflows "may be warranted in crisis or imminent crisis circumstances, without substituting for needed macroeconomic policy adjustment."
- Structural and multilateral measures:
  - "Measures to address structural factors impeding supply could ameliorate medium-term growth."
  - "Steps to strengthen multilateral cooperation are essential," including bolstering the global financial safety net, mitigating the costs of climate change, and reducing the adverse effects of geoeconomic fragmentation.

*Source: International Monetary Fund — Chapter excerpt from the April 2023 World Economic Outlook: "A Rocky Recovery."*

### CHAPTER 1 GLObAL PROsPECTs AND POLICIEs

### CHAPTER 1 GLObAL PROsPECTs AND POLICIEs

### Indebtedness Staying High
- Private and public debt have reached levels not seen in decades in most economies and remain high, despite their fall in 2021–22 on the back of the economic rebound from COVID-19 and the rise in inflation.
- Monetary policy tightening—particularly by major advanced economies—has led to sharp increases in borrowing costs, raising concerns about the sustainability of some economies’ debts.
- Among the group of emerging market and developing economies, the average level and distribution of sovereign spreads increased markedly in the summer of 2022, before coming down in early 2023.
- The share of economies at high risk of debt distress remains high in historical context, leaving many susceptible to unfavorable fiscal shocks in the absence of policy actions.

### Commodity Shocks Unwinding Even as Russia’s War in Ukraine Persists
- Russia’s invasion of Ukraine in February 2022 continues to affect the global economy.
- Europe deployed large budgetary support measures for households and firms—on the order of about 1.3 percent of GDP (net budgetary cost) in the case of the European Union—to help weather the energy crisis.
- Reorientation of gas flows and marked increases in non-Russian pipeline and liquefied natural gas deliveries to Europe, alongside demand compression from a mild winter and industrial adjustments, have dampened the negative effects of the energy crisis.
- Oil and gas prices began trending downward from their peaks in mid-2022.
- A broad decline in food and energy prices in the fourth quarter of 2022—although prices are still high—has contributed to the fall in headline inflation.
- Sustaining lower prices in 2023 depends on the absence of further negative supply shocks.

### China’s Economic Reopening
- Large COVID-19 outbreaks followed the lifting of strict containment measures, causing declines in mobility and economic activity in the fourth quarter of 2022 and temporary supply disruptions (rise in supplier delivery times).
- Property market stresses—declining property sales and real estate investment—posed a drag on activity; a large backlog of presold unfinished housing remains, generating downward pressure on house prices in some regions.
- Chinese authorities responded with additional monetary easing, tax relief for firms, new vaccination targets for the elderly, and measures to encourage the completion and delivery of unfinished real estate projects.
- As COVID-19 waves subsided in January of this year, mobility normalized and high-frequency indicators such as retail sales and travel bookings started picking up.
- China absorbs about a quarter of exports from Asia and between 5 and 10 percent from other geographic regions; the reopening and growth of its economy will likely generate positive spillovers, particularly for countries with stronger trade links and reliance on Chinese tourism.

### A Challenging Outlook
- A return of the world economy to pre-2022 growth pace is increasingly elusive; many economies are still absorbing shocks from Russia’s invasion of Ukraine and more contagious COVID-19 variants.
- Recent tightening in global financial conditions is hampering recovery, likely producing slower growth in incomes in 2023 and rising joblessness.
- Even with higher interest rates, the road back to price stability could be long; medium-term prospects for growth now seem dimmer than in decades.
- Baseline projections assume recent financial sector turmoil is contained and does not generate material disruptions to global economic activity with widespread recession.
- Baseline assumptions include fuel and nonfuel commodity prices generally declining in 2023 amid slowing global demand; crude oil prices projected to fall by about 24 percent in 2023 and a further 5.8 percent in 2024.
- Forecasts assume global interest rates will stay elevated for longer than expected at the time of the October 2022 WEO, and that governments will on average gradually withdraw fiscal policy support, including scaling back packages designed to shield households and firms as commodity prices decline.

### Feeble and Uneven Growth — Baseline Scenario
- Global output growth was estimated at 3.4 percent in 2022 and is forecast to fall to 2.8 percent in 2023, before rising to 3.0 percent in 2024.
- Compared with the January 2022 WEO Update forecast, global growth in 2023 is 1.0 percentage point lower.
- Advanced economies: growth projected to decline by half in 2023 to 1.3 percent, before rising to 1.4 percent in 2024; about 90 percent of advanced economies are projected to see a decline in growth in 2023.
- Advanced economies are expected to see higher unemployment: a rise of 0.5 percentage point on average from 2022 to 2024.
- Emerging market and developing economies (EMDEs): on average, growth is expected to be 3.9 percent in 2023 and to rise to 4.2 percent in 2024.
- Low-income developing countries: GDP expected to grow by 5.1 percent on average over 2023–24, but projected per capita income growth averages only 2.8 percent during 2023–24.
- Selected headline projections from Table 1.1 (percent change):
  - World Output: 2022 = 3.4; 2023 = 2.8; 2024 = 3.0.
  - Advanced Economies: 2022 = 2.7; 2023 = 1.3; 2024 = 1.4.
  - United States: 2022 = 2.1; 2023 = 1.6; 2024 = 1.1.
  - Euro Area: 2022 = 3.5; 2023 = 0.8; 2024 = 1.4.
  - Emerging Market and Developing Economies: 2022 = 4.0; 2023 = 3.9; 2024 = 4.2.
  - China: 2022 = 3.0; 2023 = 5.2; 2024 = 4.5.
  - India: 2022 = 6.8; 2023 = 5.9; 2024 = 6.3.
- Commodity price notes:
  - Crude oil: projected to fall by about 24 percent in 2023 and a further 5.8 percent in 2024.
  - Nonfuel commodity prices expected to remain broadly unchanged in 2023.

### Plausible Alternative Scenario
- Emphasis placed on a plausible downside scenario illustrating the impact if risks materialize amid elevated uncertainty from recent global financial market turmoil.
- The plausible alternative scenario assumes a moderate additional tightening in credit conditions resulting from further stress in individual banks vulnerable on metrics such as share of nonretail or uninsured depositors and unrealized losses.
- Funding conditions for all banks tighten due to greater concern for bank solvency and potential exposures across the financial system; stricter supervision adds to more cautious bank behavior.
- The overall impact is a decrease in the supply of credit and higher spreads for nonfinancial firms and for households.

_Italic: Source — CHAPTER 1 GLObAL PROsPECTs AND POLICIEs, text - CHAPTER 1 GLObAL PROsPECTs AND POLICIEs (PDF)._

### 4.5 percent and 2.3 percent for the United States.

### 4.5 percent and 2.3 percent for the United States.

### Global output and coverage
- Quarterly estimates and projections account for approximately 90 percent of annual world output at purchasing-power-parity weights.
- For Emerging Market and Developing Economies, quarterly estimates and projections account for approximately 85 percent of annual emerging market and developing economies’ output at purchasing-power-parity weights.
- World output projections (Table 1.2, percent change):
  - World: 3.0 (2022), 2.4 (2023), 2.4 (2024)
  - Advanced Economies: 2.6 (2022), 1.2 (2023), 1.3 (2024)
  - Emerging Market and Developing Economies: 3.6 (2022), 4.0 (2023), 4.0 (2024)
  - Emerging and Developing Asia: 3.9 (2022), 5.2 (2023), 4.8 (2024)
  - Emerging and Developing Europe: 0.3 (2022), 1.0 (2023), 2.3 (2024)
  - Latin America and the Caribbean: 3.7 (2022), 1.5 (2023), 2.1 (2024)
  - Middle East and Central Asia: 5.6 (2022), 3.0 (2023), 3.5 (2024)
  - Sub-Saharan Africa: 3.8 (2022), 3.4 (2023), 4.0 (2024)
- Memorandum items (percent change):
  - European Union: 3.5 (2022), 0.7 (2023), 1.5 (2024)
  - Middle East and North Africa: 5.8 (2022), 3.1 (2023), 3.3 (2024)
  - Emerging Market and Middle-Income Economies: 3.5 (2022), 3.9 (2023), 3.9 (2024)
  - Low-Income Developing Countries: 4.9 (2022), 4.7 (2023), 5.4 (2024)

### Plausible alternative scenario: financial tightening and effects
- Scenario summary:
  - A moderate tightening in global financial conditions with a 2 percent decline in credit in 2023 relative to the baseline, equivalent to a 150 basis point increase in corporate spreads, on average, in 2023.
  - Tightening gradually dissipates after 2023.
  - Monetary policy responds with policy rates lower than baseline; automatic fiscal stabilizers operate; no additional legislated stimulus.
  - Balance sheet policies and other interventions by central banks and regulators are implicitly assumed to help avert a larger crisis (not explicitly modeled).
- Real GDP effects (percent deviations from baseline):
  - World: decrease by 0.3 percent in 2023; 0.2 percent lower than baseline in 2024.
  - Implied real growth: about 2.5 percent in 2023 instead of 2.8 percent in baseline.
  - Advanced economies generally experience larger effects than emerging market economies.
  - United States, euro area, and Japan: about 0.4 percentage point lower growth in 2023 compared with baseline.
  - Countries with greater trade exposure to the United States (e.g., Mexico and Canada) experience sharper impacts; countries with smaller exposures (e.g., China) are less affected.

### Inflation: baseline and scenario impacts
- Baseline headline (CPI) inflation path:
  - 8.7 percent in 2022 to 7.0 percent in 2023 (a decline).
  - Global inflation excluding food and energy expected to decline much more gradually in 2023: by only 0.2 percentage point, to 6.2 percent.
  - Forecast for 2023 headline inflation is higher by 0.4 percentage point than January 2023 forecast; core inflation forecast higher by 0.5 percentage point than January 2023.
- Inflation-target comparisons:
  - For 72 inflation-targeting economies (34 advanced, 38 major emerging market and developing economies):
    - Annual average inflation will exceed targets in 97 percent of cases in 2023.
    - Median deviation from target in 2023: 3.3 percentage points.
    - In 2024, inflation expected to exceed targets in 91 percent of cases; median deviation about 1 percentage point.
    - For countries with a target range, inflation is expected to be in the target range in about 50 percent of cases in 2024.
    - By 2025, median deviation from target expected to be 0.2 percentage point.
- Plausible alternative scenario effects on inflation:
  - Global headline inflation decreases by about 0.2 percentage point more in 2023 versus baseline.
  - Oil prices decline by 3 percent more, on average, in 2023 than in the baseline.
  - Modest additional fall in inflation excluding food and energy.

### Medium-term outlook and structural drivers
- Five-year and medium-term prospects:
  - Global growth forecast at 3.0 percent looking out to 2028 — described as the lowest medium-term growth forecast published in all WEO reports since 1990.
  - Peak five-year-ahead forecasts around 4.9 percent occurred in 2008.
- Structural contributors to lower medium-term growth:
  - Progress in living standards in economies such as China and Korea leads to lower growth rates as levels converge.
  - Slower global labor force growth: United Nations medium-term population growth projections have declined since 2010 by about one-quarter of a percentage point.
  - Geoeconomic fragmentation (including Brexit, US-China trade disputes, and Russia’s invasion of Ukraine) and slower pace of supply-enhancing reforms.
- Cumulative output gap:
  - Shortfall of global GDP in 2022 compared with January 2022 WEO Update forecasts: about 1 percent.
  - By 2026, the cumulative output loss is projected to widen to 2.7 percent.

### Global trade and external balances
- World trade volume growth:
  - 5.1 percent in 2022 to 2.4 percent in 2023 (expected decline).
  - Pre-pandemic (2000–19) average was 4.9 percent.
- Global current account balances:
  - Sums of absolute surpluses and deficits expected to narrow in 2023 after a significant increase in 2022 driven largely by commodity price increases from the war in Ukraine.
  - Over the medium term, global balances expected to narrow gradually as commodity prices decline.
- Global international investment positions:
  - Creditor and debtor stock positions remained historically elevated in 2022; elevated positions expected to moderate only slightly as current account balances narrow.

### Downside risks and probabilities
- Overall risk bias: squarely to the downside.
- Estimated probabilities:
  - Probability of global growth in 2023 falling below 2.0 percent: about 25 percent (more than double the normal probability).
  - Probability of a contraction in global per capita real GDP in 2023: about 15 percent.
  - Probability of global headline inflation exceeding its 2022 level in 2023: less than 10 percent.
  - Probability for core inflation exceeding its 2022 level in 2023: 30 percent.
- Major downside scenarios and channels:
  - Severe tightening in global financial conditions:
    - Bank lending in the United States and other advanced economies could sharply decline; household and business confidence would deteriorate; precautionary saving would rise; investment would fall; spillovers would lower import demand and commodity prices.
    - Broad-based capital outflows from emerging market and developing economies could occur, causing further dollar appreciation and worsening vulnerabilities in dollar-denominated external debtors.
    - Box 1.3 quantification: severe financial sector stress could reduce global real GDP growth in 2023 by 1.8 percentage points below baseline, implying near-zero growth in global GDP per capita; global headline and core inflation lower by about 1 percentage point in 2023.
  - Sharper monetary policy impact amid high debt:
    - Rising real interest rates combined with historically elevated corporate and household debt could cause debt overhang, lower investment and consumption, higher unemployment, and widespread bankruptcies (notably where house prices and household floating-rate debt are elevated).
  - Stickier inflation:
    - Tight labor markets and stronger-than-expected wage growth could stall disinflation; an even-stronger-than-predicted rebound in China or escalation of the war in Ukraine could reverse commodity price declines, raising headline and core inflation and prompting further monetary tightening.
  - Systemic sovereign debt distress in emerging market and developing economies:
    - About 56 percent of low-income developing countries estimated to be either already in debt distress or at high risk of it.
    - About 25 percent of emerging market economies estimated to be at high risk.
    - Share of external debt owed to Paris Club official bilateral creditors fell from 39 percent in 1996 to 12 percent in 2020; non–Paris Club official bilateral creditors rose from 8 percent to 22 percent; private creditors doubled from 8 percent to 16 percent.
  - Faltering growth in China: risks include weakness in the Chinese real estate market posing a larger-than-expected drag on growth and potential financial stability risks.
  - Escalation of the war in Ukraine: could trigger renewed energy crises in Europe and exacerbate food insecurity in low-income countries; risk of food price increases from a failed extension of the Black Sea Grain Initiative.
  - Fragmentation further hampers multilateral cooperation: retreat from cross-border economic integration and geopolitical fragmentation can raise barriers to trade and cooperation.

*Source: IMF staff estimates and staff calculations, Chapter 1, World Economic Outlook: A Rocky Recovery (April 2023).*

### 1. External Debt Measures

### 1. External Debt Measures

### External Debt Vulnerabilities
- Emerging market and developing economies exhibit high external debt vulnerabilities (Figure 1.20).
- Data sources: IMF-World Bank LIDC Debt Sustainability Analysis Database; World Bank International Debt Statistics; and IMF staff calculations.
- Note: Panels show unweighted averages across emerging market and developing economies; panel 3 shows percent of PRGT-eligible countries with risks of debt distress; classification details in IMF (2018). Abbreviations: LIDCs = low-income developing countries; PPG = public and publicly guaranteed; PRGT = Poverty Reduction and Growth Trust.

### Geopolitical and Trade Tensions
- Geopolitical risk and harmful trade restrictions have risen over time (Figure 1.21).
- Examples of measures: export bans on food and fertilizers; restrictions on trade in micro-chips and semiconductors; local-content requirements aimed at preventing technology transfer.
- Risks: Lower cross-border flows of labor, goods, and capital; reduced international action on public goods (climate mitigation, pandemic resilience); short-term costs likely high during rearrangement of global production.
- Sources: Caldara and Iacoviello (2022); Global Trade Alert. Note: data on harmful trade restrictions are as of February 1, 2023.

### Policy Priorities: Walking a Narrow Path
- Central objective: restore price stability while avoiding recession and maintaining financial stability; policymakers must stay agile and data-dependent.

- Policies with Immediate Impact — Ensuring a durable fall in inflation:
  - Steady but ready monetary policy:
    - Under the baseline forecast, real (inflation-adjusted) policy rates in major economies are expected to increase gradually, even as the pace of nominal rate rises slows on the back of declining inflation (Figure 1.22).
    - Where core inflation pressures persist, raising real policy rates and holding them above their neutral levels would ward off de-anchoring inflation expectations.
    - Under a plausible alternative scenario with cooling real activity, central banks would need to carefully recalibrate monetary policy, including timing and size of policy rate changes.
    - If a severe downside scenario materializes and financial stability is at stake, substantial readjustment of monetary policy paths might be needed to minimize economic damage and contain financial sector contagion.
  - Clear communication:
    - Reinforce communication about the likely need for a restrictive monetary policy stance until tangible evidence shows inflation returning toward target.
    - Reassure markets that policymakers stand ready to change course and use the full set of available instruments should market turmoil deepen.
    - Real interest rate consistent with stable inflation (r*) and natural rate of unemployment (u*) are highly uncertain—for example, recent estimates of u* for the United States range from 4 percent to 7 percent, which is above the current unemployment rate and has contributed to projections of rising unemployment by 2024 (Figure 1.23).
  - Applying lessons from past premature easing:
    - Premature easing can increase the costs of disinflation (US experience in early 1980s): initial loosening led to expectations of entrenched inflation and necessitated a second wave of sharp policy rate increases with larger negative growth and employment implications (Figure 1.24).

- Safeguarding financial stability:
  - Monitoring risks:
    - More intensive and high-frequency monitoring across banks, nonbank financial institutions, and the housing sector as central banks raise rates and unwind balance sheets (see April 2023 Global Financial Stability Report).
  - Managing market strains:
    - Deploy liquidity-support tools promptly and forcefully when strains emerge, while mitigating moral hazard.
    - Liquidity support should be targeted, properly collateralized, and preserve monetary policy transmission.
    - Intervention and resolution procedures may need prompt initiation for weak and nonviable institutions.
  - Strengthening oversight:
    - Address shortcomings in supervisory oversight, including prudential framework for exposures to interest rate risk.
    - Ensure alignment with the Basel framework on capital and liquidity regulations.
    - Intensify supervision commensurate with banks’ risks and systemic importance and address supervisory gaps in the nonbank financial sector.
  - Using the global financial safety net:
    - Employ IMF precautionary financial arrangements; focus aid on low-income countries through rechanneling of special drawing rights and support from the Poverty Reduction and Growth Trust and the Resilience and Sustainability Trust.
    - Enhanced dollar funding swap lines between the Federal Reserve and major advanced economy central banks should help limit strains; ensure other central banks can access liquidity to guard against external funding shocks.

- Dealing with currency swings:
  - The US dollar has depreciated in real terms since October 2022—by 6   percent on a trade-weighted basis—but remains stronger than it has been since 2000 (Figure 1.25).
  - Emerging market economies should let currencies adjust as much as possible; temporary foreign exchange interventions may be appropriate if movements and capital flows substantially raise financial stability risks or jeopardize price stability.
  - Temporary capital flow management measures on outflows may be useful in a crisis but should not substitute for needed macroeconomic adjustment. Examples of economies resorting to capital flow management measures in 2022: China and Malawi (among others).

- Normalizing fiscal policy:
  - With deficits and debts above pre-pandemic levels, fiscal efforts warranted in 2023 to support monetary policy in getting inflation back to target.
  - In a severe downside scenario, allow automatic stabilizers to operate fully and use temporary support measures as needed, considering available fiscal space (see April 2023 Fiscal Monitor).
  - Protect the vulnerable through targeted measures; broad-based fiscal support can become increasingly costly and should be replaced by more targeted approaches (Figure 1.26).

- Supporting the vulnerable and food security:
  - 2022 surge in energy and food prices triggered a cost-of-living crisis; many low-income countries face food insecurity.
  - Restrictions on exports of food and fertilizers risk pushing large shares of the global population into food insecurity—emerging market and developing economies’ net imports of wheat account for more than half of total wheat consumption while domestic storage tends to be low (Figure 1.27).
  - Restrictions—particularly recent ones—should be lifted to safeguard global food supplies and distribution.

### Policies with Payoffs in the Medium Term
- Restoring debt sustainability:
  - Lower growth and higher borrowing costs are making public debt ratios unsustainable in many countries.
  - Actions needed: fiscal consolidation, structural reforms to create sound policy frameworks and revitalize growth.
  - Debt restructuring may be necessary for some economies; preemptive restructuring is associated with smaller declines in output, investment, private sector credit, and capital inflows than restructuring after default (Chapter 3).
  - International cooperation needed: creditors (official and private, including non–Paris Club creditors) must be ready to respond swiftly; mechanisms needed for middle-income economies not eligible under current frameworks.
  - The Global Sovereign Debt Roundtable (GSDR) aims to identify impediments and design standards/processes for restructurings.

- Reinforcing supply:
  - Supply-side policies to address structural impediments: reduce harmful market power and rent-seeking; simplify overly rigid regulation and planning.
  - Stimulate investment in infrastructure and productive digitalization; enhance access to and quality of education.
  - Reduce labor market tightness: bolster active labor market policies (short-term training), increase work flexibility (telework, leave policies), and resume regular immigration flows.
  - Industrial policy may be pursued when frictions are well established, but must avoid distortions, be consistent with international agreements and WTO rules, and avoid wasteful subsidy races and domestic production requirements.

- Containing pandemic risks:
  - Remain vigilant to reemergence of COVID-19 and new pandemics.
  - Coordinate to boost access to vaccines and medicines where immunity is low; increase public support for vaccine development and systematic epidemic responses.

### Policies for a Better Long Term
- Strengthening multilateral cooperation:
  - Coordinated responses needed to bolster resilience and improve outcomes amid geopolitical fragmentation.
  - Strengthen multilateral trading system: upgrade WTO rules in areas like agricultural and industrial subsidies, implement new WTO-based agreements, and fully restore the WTO dispute settlement system.

- Speeding up the green transition:
  - Current progress in emissions reductions is inadequate to contain global warming at 2°C or less.
  - International coordination on carbon pricing or equivalent policies would facilitate faster, cost-efficient decarbonization.
  - With declining fossil fuel investment, push alternative clean energy investment via investment incentives for green materials and grid upgrades, ease permitting for renewables, and support research and development.
  - COP27 meetings yielded encouraging signs on adaptation cooperation, but more action is needed, including channeling aid to vulnerable countries.

*Italic: Source: World Economic Outlook: A Rocky Recovery, Chapter 1, International Monetary Fund | April 2023.*

### CHAPTER 1 Global ProsPects and Policies

### CHAPTER 1 Global ProsPects and Policies

### Housing markets and risks
- During the COVID-19 pandemic, real house prices rose to record levels in many countries—especially among advanced economies—driven by ample policy support and limited numbers of available properties.
- In 2022:Q2, quarterly real house prices fell: about two-thirds of economies experienced negative growth and the remainder experienced positive but slower growth.
- Mortgage rate developments:
  - Mortgage rates climbed to an average of 6.8 percent in advanced economies in late 2022.
  - Mortgage rates were 2.8 percent in January 2022.
- Vulnerabilities and exposure:
  - Economies with elevated house prices and high levels of household debt issued at floating rates are particularly vulnerable to financial sector stress from rising mortgage rates.
  - Economies in which house prices rose more during the pandemic are likely to see housing markets cool more and be more sensitive to policy rate hikes.
  - Economies where house prices increased rapidly and affordability declined but household debt remained moderate are expected to experience a more gradual price decline, which could improve affordability.

### How this housing episode compares with the 2007–08 Global Financial Crisis
- Banking sector resilience and household leverage:
  - Regulatory Tier 1 capital to risk-weighted assets averaged 17.5 percent across countries in 2021, compared with 13.4 percent in 2007.
  - The average household debt-to-income ratio across countries in 2022 was on par with that in 2007, driven mainly by households in economies that largely avoided the global financial crisis and subsequently increased borrowing.
- China-specific considerations:
  - The real estate sector in China experienced a protracted contraction, with early signs of stabilization in 2023.
  - The real estate and construction sectors account for about one-fifth of final demand absorption in China.
  - Share prices of property developers rebounded partially following support measures announced in November 2022, but a correction in house prices could intensify financial stress for property developers.
  - The share of property developers in need of restructuring remains large.

### Monetary policy: speed of transmission, heterogeneity, and asymmetries
- Transmission timing (literature review and meta-analysis):
  - Estimates of the timing of monetary policy transmission to output vary between near-immediate effects and a lag of about three quarters; output usually reverts to its initial level within two to three years, though more persistent effects may occur.
  - Estimates of the lag to prices vary; at the upper end a delay of about 1.5 to 2.5 years is reported, while some studies find immediate price responses once information effects are accounted for.
  - A meta-analysis of 67 studies finds the effect of a tightening on prices takes an average of about three years to reach its trough, with a wide range; prices in advanced economies take about twice the time needed in emerging market and developing economies.
- Factors affecting transmission speed and strength:
  - Financial development: Developed financial systems provide more hedging opportunities, potentially delaying impact, but more competitive financial sectors show faster and more complete interest rate pass-through.
  - Financial frictions: Greater frictions increase investment sensitivity to monetary policy, leading to larger declines in investment, higher capital misallocation, and productivity declines.
  - Central bank credibility and communication: Better-anchored inflation expectations and central bank independence improve effectiveness and lower output costs of restoring price stability.
  - Household wealth and income distribution: Households with mortgages are most responsive to tightening (reducing durables spending); liquidity positions across households shape consumption responses.
  - Nominal rigidities: Greater wage rigidities amplify output effects; mortgage rate rigidities dampen effects. A large share of adjustable-rate mortgages amplifies contractionary output effects—adjustable-rate mortgages are more common in emerging market and developing economies.
- Asymmetric effects:
  - Evidence suggests policy easing has large effects on prices but small effects on real activity, whereas policy tightening has large output effects, especially during booms, but small effects on prices.
  - Asymmetries may stem from downward nominal rigidities, interaction with fiscal policy, or changes in firms’ price-setting when inflation rises.
- Implication given current environment:
  - With exceptionally synchronous global tightening, widespread withdrawal of fiscal support, sharply increasing residential mortgage rates, and financial conditions highly sensitive to policy news, a shorter transmission lag than in the past could occur in several countries.
  - Clear and effective communication by major central banks to keep inflation expectations anchored is expected to further accelerate policy transmission.

### Risk assessment and a severe downside scenario (G20 Model analysis)
- Baseline uncertainty and confidence bands:
  - The risk of global growth falling below 2 percent in 2023 is about 25 percent.
  - For global growth, there is a 70 percent probability that 2023 global growth could be between 1.0 percent and 3.8 percent.
  - For 2024, there is a 70 percent probability that growth will be between 1.4 percent and 4.3 percent.
  - For global headline inflation, there is a 70 percent chance that 2023 headline inflation could be about 1.2 percentage points higher or lower than currently projected.
  - For global core inflation, the 70 percent range is 0.7 percentage point higher or lower than the baseline.
  - The distributions for near-term inflation are skewed to the upside; the chance that core inflation will be higher in 2023 than in 2022 is close to 30 percent.
- Severe downside scenario layers and assumed shocks:
  - Credit supply shock:
    - Bank lending in the United States decreases by 4 percent in 2023 relative to the current baseline projections (about one-fifth of the contraction in credit experienced during the global financial crisis, relative to the precrisis trend).
    - Corporate spreads increase by 250 basis points in 2023.
    - Euro area countries and Japan experience shocks similar in magnitude to the United States; other countries experience shocks varying with correlation to US financial conditions. China’s domestic financial conditions are assumed to be only slightly affected.
  - Equity prices:
    - Global equity prices fall by 10 percent on impact and by about 6 percent on average in 2023.
  - Flight to safety and dollar appreciation:
    - In emerging markets excluding Asia, sovereign premiums increase considerably and the US dollar appreciates by close to 10 percent.
    - The shock for emerging market economies in Asia is about half as large; China is not directly affected in this assumption.
  - Confidence and demand channels:
    - Greater precautionary saving—assumed to be about 75 percent of the estimated increase in precautionary saving during the global financial crisis—leads to a decrease in consumption; a decline in business sentiment leads to a decrease in investment.
    - In this layer, US consumption and investment decrease by 0.3 and 1 percent, respectively, relative to the baseline.
- Policy response assumptions and caveats:
  - Monetary policy responds endogenously to decreases in activity and inflationary pressures.
  - Fiscal policy: automatic stabilizers operate in advanced economies but not in emerging markets in the scenario.
  - Balance sheet policies and other central bank/regulatory interventions to preserve financial stability are not explicitly modeled; such interventions should be thought of as helping avert a crisis and would have larger effects on activity than shown.
  - The potential fiscal cost of interventions and effects on fiscal stances are not considered; if fiscal policy tightens in response to debt sustainability strains, the macroeconomic impact would be larger.
- Impact on world output and inflation:
  - The scenario reduces global activity sharply and lowers core inflation relative to baseline; contributions from each layer (credit conditions, equity prices, dollar appreciation and flight to safety, confidence) add in stacked form to produce cumulative deviations from the baseline for 2023 and 2024.

*Source: CHAPTER 1 Global ProsPects and Policies, text - CHAPTER 1 Global ProsPects and Policies (PDF).*

### Box 1.3 (continued)

### Box 1.3 (continued)

### Impact of Downside Scenario on Global Activity and Inflation
- Credit conditions layer subtracts 0.5 percent from global output in 2023; impact larger in the United States and other advanced economies than in emerging markets; impact on China is small.
- Appreciation of the US dollar vis-à-vis emerging market economies’ currencies and tightening in emerging market (and some advanced) economies’ sovereign premiums subtract another 0.2 percent globally in 2022; effect larger in emerging market economies, at –0.4 percent in 2023.
- Decline in equity prices subtracts another 0.5 percent from global output in 2023, with a somewhat larger impact in advanced economies than in emerging markets.
- Confidence layer subtracts 0.5 percent from global activity in 2023, with advanced economies again seeing a larger hit to activity than emerging markets.
- Combined effect from all layers implies a decrease in the level of global output of 1.8 percent in 2023 and 1.4 percent in 2024, relative to the baseline.
- Overall effect on global output is about one-fourth the size of the impact of the global financial crisis during 2008–09.
- United States and other advanced economies see a broadly similar hit to activity (1.8 percent in 2023).
- Emerging market economies excluding China see an effect of –1.9 percent in 2023, due mainly to the dollar appreciation layer.
- China experiences a smaller impact overall (–1.2 percent).
- Oil prices fall by close to 15 percent in 2023 relative to the baseline, due to the decrease in global demand, before gradually returning to the baseline over the projection horizon.
- Disinflationary impulse: global core inflation declines by 0.9 percentage point in 2023 and by 1.1 percentage points in 2024, relative to the baseline.
  - Disinflation is more pronounced in emerging markets excluding China, due to the assumption that Phillips curves are steeper; decline in inflation is sizable in advanced economies as well.
- Policy rates (not shown) decline materially in this scenario:
  - US policy rates decline by 1.6 percentage points in 2023 and 1.8 percentage points in 2024, relative to the baseline.
  - Global average of policy rates declines by 2.1 and 2.3 percentage points in 2023 and 2024, respectively.

### Commodity Market Developments (August 2022 – February 2023)
- Primary commodity prices declined 28.2 percent between August 2022 and February 2023.
  - Energy commodities down 46.4 percent.
  - European natural gas prices declined by 76.1 percent amid lower consumption and high storage levels.
  - Base metal prices rebounded by 19.7 percent.
  - Precious metal prices rebounded by 3.3 percent.
  - Food prices increased slightly, by 1.9 percent.
- Crude oil prices retreated by 15.7 percent between August 2022 and February 2023.
- Futures markets imply crude oil prices will slide by 24.1 percent, to average $73.1 a barrel in 2023 (from $96.4 in 2022) and continue to fall to $65.4 in 2026.
- Natural gas (European TTF) receded 76.1 percent from record highs in August 2022 to $16.7 a MMBtu in February 2023.
- Coal prices slid 50.9 percent over the reference period.
- Base metal price index increased by 19.7 percent from August 2022 to February 2023; IMF’s energy transition metal index increased 14.3 percent.
  - Gold prices rose by 5.1 percent; central banks’ net purchases broke a 55-year record.
  - Base metal price index projected to increase 3.5 percent in 2023 and then decrease 2.6 percent in 2024.
- Agricultural and food markets:
  - Food and beverage prices peaked in May 2022 and are up 1.3 percent from last August.
  - Food and beverage prices remain 22.3 percent above the past-five-year average and 39.1 percent above pre-pandemic levels.
  - Raw agricultural materials declined by 9.1 percent from last August.

### The Macroeconomic Impact of Declines in Fossil Fuel Extraction
- Context: Reaching net zero emissions by 2050 requires an 80 percent reduction in global fossil fuel extraction compared with 2021 levels (International Energy Agency (2022) cited).
- Focus: estimates of the macroeconomic impact of persistent declines in extraction activity (production declines), recognizing uncertainty about price effects from climate policies.
- Countries highly dependent on fossil fuel output:
  - Between 2010 and 2019, average oil and gas production-to-GDP ratios were large in countries such as Angola, Azerbaijan, the Republic of Congo, Kuwait, and Saudi Arabia.
  - Gas production particularly relevant in Qatar and Trinidad and Tobago.
  - Coal production less relevant to GDP at country level except Mongolia.
  - Ratios of net exports of oil and gas to GDP surpassed 25 percent on average over 2010–2019 in more than ten countries.
- New data set and identification:
  - New data on extraction of oil, coal, gas, and metals for countries worldwide from 1950 to 2020.
  - Identified 35 episodes involving persistent declines in extractive activity out of a total of 154 observed episodes; verified drivers are exogenous to economic conditions (depletion or sector-specific policy changes).
  - Typical episode: 10 percent contraction in extraction activity in the episode’s first year, cumulating to a 40 percent reduction over 10 years.

### Empirical Strategy and Estimated Effects
- Method: local projections following Jordà (2005) estimate cumulative effects up to 10 years on real GDP and external and domestic sectors; baseline includes country fixed effects, time fixed effects, three lags of the dependent variable, and a shock series to handle autocorrelation.
- Representative quantitative impacts of a typical extraction-decline episode:
  - Real GDP falls by 1 percent initially from the baseline and cumulates to 5 percent after five years; decline is persistent with no rebound through the horizon.
  - Real exchange rate depreciates slowly by 20 percent.
  - Trade balance worsens, driven by a decline in exports of about 6 percent.
  - Imports and investment decline (estimates less precise).
  - Aggregate consumption responds only with a lag of more than five years.
  - Manufacturing and services value added fall significantly by about 5 percent.
  - Negative manufacturing and services spillovers more than offset potential benefits from the real exchange rate depreciation.
  - Negative impact on employment is small, likely due to high capital intensity of the extraction sector.

### Heterogeneity: Role of Institutions and Initial Structure
- Countries with larger initial shares of manufacturing in value added fare better, suggesting the presence of sunk costs and advantages for existing exporting manufacturing firms.
- Institutional quality matters:
  - Estimated GDP impact is significantly larger for middle- and low-income countries than for high-income countries.
  - Five years after the shock, the GDP difference between countries with high and low institutional quality is about 5 percentage points.
  - Declines in extraction activity do not restore the quality of institutions within a decade, suggesting hysteresis and asymmetric institutional responses.

### Anticipation and Robustness
- Potential anticipation bias explored by reviewing IMF Article IV projections versus actual production for 26 decline episodes with Article IV coverage (analysis ongoing in full study).

*Source: IMF staff calculations and analysis as presented in Box 1.3 (continued), World Economic Outlook, April 2023.*

### 1. Real GDP2. Role of Institutions

### 1. Real GDP2. Role of Institutions

### Responses to an Extraction Decline Shock
- Empirical evidence shows that most observed extraction-decline episodes were not anticipated: only 4 were anticipated, while in the other 22 extraction was expected either to increase or to remain stable (or in a few cases, it was not mentioned).
- Lack of anticipation appears to have delayed economic adjustment, with private and public consumption initially increasing and then declining only with a delay to a 4 percent lower level.
- The exchange rate typically moves only modestly and in a statistically nonsignificant way following an extraction decline shock.
- Figures summarize dynamic responses of macroeconomic variables (x-axis unit: years after the shock) with shaded areas representing 90 percent confidence intervals.

### Institutional Quality, Manufacturing Sector Size, and Shock Transmission
- The response of institutional quality interacted with manufacturing sector size is analyzed in the context of extraction decline shocks (responses shown in percent; x-axis unit: years after the shock; 90 percent confidence intervals shown).

### Policy Recommendations for a More Challenging Energy Transition
- Countries at risk of declining fossil fuel output should prepare for potentially challenging structural adjustment by:
  - Improving public finances and the quality of their institutions (for example, by enhancing the management of public sector institutions and the regulatory business environment).
  - Diversifying their economies.
  - Setting up sovereign wealth funds.
  - Facilitating the reallocation of production factors.
- Possible policy actions to achieve these goals include:
  - Ameliorating the business environment to attract investment in new, productive, higher-value-added sectors.
  - Modernizing infrastructure and attracting foreign direct investment in research and development.
  - Improving the human capital stock of the labor force by investing in education.
- The pace and direction of the clean energy transition and the fossil fuel price outlook depend on the global and national policy mix:
  - If climate policy acts mostly through the demand side, fossil fuel prices may decline and high-cost producers will need to shut down production.
  - If climate policy relies on supply cuts, prices may rise and local production declines will depend on domestic policy decisions.
  - Greater climate policy certainty at the country and global levels could make adjustments more predictable and less costly.

### Selected Regional and Aggregate Statistics (from Annexes)
- Figures and tables present country and regional projections for Real GDP, Consumer Prices, Current Account Balance (percent of GDP), and Unemployment (percent), covering multiple regions and economies.
- Notable aggregate and country-level figures presented in the annexes include:
  - World (summary of world real per capita output row): 2.3; 2.1; 1.9; 2.4; 2.4; 1.6; –4.0; 5.7; 2.4; 1.8; 2.0 (annual percent change; in constant 2017 international dollars at purchasing power parity).
  - Advanced Economies (same summary table row): 0.9; 1.7; 1.3; 2.1; 1.9; 1.3; –4.7; 5.3; 2.3; 0.9; 1.0.
  - Emerging Market and Developing Economies (same summary table row): 4.4; 2.8; 2.9; 3.3; 3.3; 2.3; –3.1; 6.1; 2.8; 2.8; 3.0.
  - Regional and country projections are tabulated across Annex Tables 1.1.1–1.1.5, including Europe, Asian and Pacific economies, Western Hemisphere economies, Middle East and Central Asia economies, and Sub-Saharan African economies — each table reports Real GDP, Consumer Prices (annual averages), Current Account Balance (percent of GDP), and Unemployment (percent) for 2022, projections for 2023 and 2024 (as presented).
- Notes accompanying the annex tables:
  - Movements in consumer prices are shown as annual averages; year-end to year-end changes are available in the Statistical Appendix.
  - Current account balances are percent of GDP.
  - Unemployment is measured in percent, with national definitions possibly differing.
  - Some country data are based on fiscal years; consult Table F in the Statistical Appendix for economies with exceptional reporting periods.
  - Several regional aggregates and country group definitions are specified in notes (for example, ASEAN-5 comprises Indonesia, Malaysia, Philippines, Singapore, and Thailand).

*Source: IMF staff estimates, World Economic Outlook: A Rocky Recovery (April 2023).*

### References

### References

### Major themes and topics covered by cited works
- Geoeconomic fragmentation and multilateralism
  - Aiyar, Shekhar, Jiaqian Chen, Christian Ebeke, Roberto Garcia-Saltos, Tryggvi Gudmundsson, Anna Ilyina, Alvar Kangur, and others. 2023. “Geoeconomic Fragmentation and the Future of Multilateralism.” Staff Discussion Note 2023/001, International Monetary Fund, Washington, DC. https:// www .imf .org/ en/ Publications/ Staff -Discussion -Notes/ Issues/ 2023/ 01/ 11/ Geo -Economic -Fragmentation -and -the -Future -of -Multilateralism -527266.
- Price setting, inflation dynamics, and menu costs
  - Albagli, Elías, Francesco Grigoli, and Emiliano Luttini. 2023. “Sticky or Flexible Prices? Firms’ Price Setting during High Inflation Periods.” Unpublished, International Monetary Fund, Washington, DC.
  - Alvarez, Fernando E., Francesco Lippi, and Luigi Paciello. 2011. “Optimal Price Setting with Observation and Menu Costs.” Quarterly Journal of Economics 126 (4): 1909–60. https:// doi .org/ 10    .1093/ qje/ qjr043.
  - Nakamura, Emi, and Jón Steinsson. 2008. “Five Facts about Prices: A Reevaluation of Menu Cost Models.” Quarterly Journal of Economics 123 (4): 1415–64. https:// doi .org/ 10    .1162/ qjec .2008 .123 .4 .1415.
- Monetary policy measurement, transmission, and credibility
  - Alvarez, Jorge, and Allan Dizioli. 2023. “How Costly Will Reining in Inflation Be? It Depends on How Rational We Are.” IMF Working Paper 23/21, International Monetary Fund, Washington, DC. https:// www .imf .org/ en/ Publications/ WP/ Issues/ 2023/ 02/ 03/ How -Costly -Will -Reining -in -Inflation -Be -It  -Depends -on -How -Rational -We -Are -529103.
  - Bernanke, Ben S., Jean Boivin, and Piotr Eliasz. 2005. “Measuring the Effects of Monetary Policy: A Factor-Augmented Vector Autoregressive (FAVAR) Approach.” Quarterly Journal of Economics 120 (1): 387–422. https:// doi .org/ 10    .1162/ 0033553053327452.
  - Romer, Christina, D., and David H. Romer. 2004. “A New Measure of Monetary Shocks: Derivation and Implications.” American Economic Review 94 (4): 1055–84. https:// doi .org/ 10    .1257/ 0002828042002651.
  - Choi, Jason, Taeyoung Doh, Andrew Foerster, and Zinnia Martinez. 2022. “Monetary Policy Stance Is Tighter Than Federal Funds Rate.” FRBSF Economic Letter 2022–30, Federal Reserve Bank of San Francisco, San Francisco, CA.
  - Crump, Richard K., Stefano Eusepi, Marc Giannoni, and Ayşegül Şahin. 2022. “The Unemployment-Inflation Trade-Off Revisited: The Phillips Curve in COVID Times.” NBER Working Paper 29785, National Bureau of Economic Research, Cambridge, MA.
- Financial heterogeneity, credit, and investment
  - Ottonello, Pablo, and Thomas Winberry. 2020. “Financial Heterogeneity and the Investment Channel of Monetary Policy.” Econometrica 88 (6): 2473–502. https:// doi .org/ 10 .3982/ ECTA15949.
  - Jeenas, Priit. 2019. “Firm Balance Sheet Liquidity, Monetary Policy Shocks, and Investment Dynamics.” Unpublished.
  - Di Maggio, Marco, Amir Kermani, Benjamin J. Keys, Tomasz Piskorski, Rodney Ramcharan, Amit Seru, and Vincent Yao. 2017. “Interest Rate Pass-Through: Mortgage Rates, Household Consumption, and Voluntary Deleveraging.” American Economic Review 107 (11): 3550–88. https:// doi .org/ 10 .1257/ aer .20141313.
- Labor markets, u*, and Phillips-curve dynamics
  - Duval, Romain, Yi Ji, Longji Li, Myrto Oikonomou, Carlo Pizzinelli, Ippei Shibata, Alessandra Sozzi, and Marina M. Tavares. 2022. “Labor Market Tightness in Advanced Economies.” IMF Staff Discussion Note 2022/01, International Monetary Fund, Washington, DC.
  - Michaillat, Pascal, and Emmanuel Saez. 2022. “u* = √uv.” NBER Working Paper 30211, National Bureau of Economic Research, Cambridge, MA.
  - Tenreyro, Silvana, and Gregory Thwaites. 2016. “Pushing on a String: US Monetary Policy Is Less Powerful in Recessions.” American Economic Journal: Macroeconomics 8 (4): 43–74. https:// doi .org/ 10    .1257/ mac .20150016.
- Natural resources, resource booms, and the energy transition
  - Brunnschweiler, Christa N., and Erwin H. Bulte. 2008. “The Resource Curse Revisited and Revised: A Tale of Paradoxes and Red Herrings.” Journal of Environmental Economics and Management 55 (3): 248–64. https:// doi .org/ 10 .1016/ j .jeem .2007 .08 .004.
  - Cavalcanti, Tiago, Daniel Da Mata, and Frederik Toscani. 2019. “Winning the Oil Lottery: The Impact of Natural Resource Extraction on Growth.” Journal of Economic Growth 24 (1): 79–115.
  - Watson, Brett, Ian Lange, and Joshua Linn. 2023. “Coal Demand, Market Forces, and US Coal Mine Closures.” Economic Inquiry 61 (1): 35–57. https:// doi .org/ 10 .1111/ ecin .13108.
  - Hanson, Gordon H. 2023. “Local Labor Market Impacts of the Energy Transition: Prospects and Policies.” NBER Working Paper 30871, National Bureau of Economic Research, Cambridge, MA.
  - Bems, Rudolfs, Lukas Boehnert, Andrea Pescatori, and Martin Stuermer. Forthcoming. “Economic Consequences of Large Extraction Declines: Lessons for the Green Transition.” IMF Working Paper, International Monetary Fund, Washington, DC.
- Model frameworks, estimation methods, and databases
  - Andrle, Michal, Patrick Blagrave, Pedro Espaillat, Keiko Honjo, Benjamin Hunt, Mika Kortelainen, René Lalonde, and others. 2015. “The Flexible System of Global Models—FSGM.” IMF Working Paper 15/64, International Monetary Fund, Washington, DC.
  - Andrle, Michal, and Benjamin Hunt. 2020. “Model-Based Globally-Consistent Risk Assessment.” IMF Working Paper 20/64, International Monetary Fund, Washington, DC.
  - Barnichon, Regis, and Christian Matthes. 2018. “Functional Approximation of Impulse Responses.” Journal of Monetary Economics 99: 41–55. https:// doi .org/ 10    .1016/ j .jmoneco .2018 .04 .013.
  - Jordà, Òscar. 2005. “Estimation and Inference of Impulse Responses by Local Projections.” American Economic Review 95 (1): 161–82. https:// doi .org/ 10    .1257/ 0002828053828518.
  - Montiel Olea, José Luis, and Mikkel Plagborg-Møller. 2021. “Local Projection Inference Is Simpler and More Robust Than You Think.” Econometrica 89 (4): 1789–823.
- IMF institutional publications and data sources
  - International Monetary Fund (IMF). 2018. “ Guidance Note on the Bank-Fund Debt Sustainability  Framework for Low Income Countries.”
  - International Monetary Fund (IMF). 2021. Financial Soundness Indicators. Washington, DC.
  - International Monetary Fund (IMF). 2022a. “Macroeco­nomic Developments and Prospects in Low-Income Countries—2022.” IMF Policy Paper 22/054, Washington, DC.
  - International Monetary Fund (IMF). 2022b. “People’s Republic of China: 2021 Article IV Consultation.” IMF Country Report 22/21, Washington, DC.
  - International Monetary Fund (IMF). 2023. “People’s Republic of China: 2022 Article IV Consultation.” IMF Country Report 23/67, Washington, DC.

### Representative empirical and methodological contributions (selected entries with identifiers)
- IMF Working Papers and Staff Discussion Notes
  - IMF Working Paper 23/21 (Alvarez and Dizioli, 2023).
  - IMF Working Paper 15/64 (The Flexible System of Global Models—FSGM, Andrle et al., 2015).
  - IMF Working Paper 20/64 (Andrle and Hunt, 2020).
  - IMF Working Paper 2022/152 (Ari et al., 2022).
  - IMF Working Paper 22/255 (Grigoli and Sandri, 2022).
  - IMF Staff Discussion Note 2023/001 (Aiyar et al., 2023).
  - IMF Staff Discussion Note 2022/01 (Duval et al., 2022).
- Journal articles and books with methodological relevance
  - Quarterly Journal of Economics 126 (4): 1909–60 (Alvarez, Lippi, and Paciello, 2011).
  - American Economic Review 112 (4): 1194–225 (Caldara and Iacoviello, 2022).
  - Econometrica 88 (6): 2473–502 (Ottonello and Winberry, 2020).
  - Journal of Monetary Economics 99: 41–55 (Barnichon and Matthes, 2018).

### Key thematic finding excerpted from chapter text included in references section
- On the natural rate of interest:
  - The natural rate of interest—the real interest rate that neither stimulates nor contracts the economy—is important for both monetary and fiscal policy; it is a reference level to gauge the stance of monetary policy and a key determinant of the sustainability of public debt.
  - The chapter aims to study the evolution of the natural rate of interest across several large advanced and emerging market economies.
  - To mitigate the uncertainty that typically surrounds estimates of the natural rate, the chapter relies on complementary approaches to analyze its drivers and project its future path.
  - Common trends such as demographic changes and productivity slowdown have been key factors in the synchronized decline of the natural rate.
  - International spillovers have been important determinants of the natural rate, but offsetting forces have resulted in only a moderate impact on balance.
  - Overall, the analysis suggests that once the current inflationary episode has passed, interest rates are likely to revert toward pre-pandemic levels in advanced economies.
  - How close interest rates get to those levels will depend on whether alternative scenarios involving persistently higher government debt and deficit or financial fragmentation materialize.
  - In major emerging market economies, natural interest rates are expected to gradually converge from above toward advanced economies’ levels.
  - In some cases, this may ease the pressure on fiscal authorities over the long term, but fiscal adjustments will still be needed in many countries to stabilize or reduce debt-to-GDP ratios.

*Source: References section, text - References (text extracted from the cited PDF).*

### Introduction

### Introduction

### Background and motivation
- In 1979, the Federal Reserve hiked interest rates from about 10 percent at the start of the year to almost 14 percent by the year’s end, which in real terms—after taking account of inflation—amounted to a rate of interest of about 5 percent.
- Inflation continued to rise, peaking at nearly 15 percent the following year, requiring even higher interest rates and a prolonged recession before the situation was brought under control.
- Nearly three decades later, during the global financial crisis of 2008, central banks slashed interest rates to as close to zero as they thought possible in nominal and real terms; inflation remained stubbornly low for much of the next 10 years.
- These contrasting episodes motivate the central question: How can the same real interest rate be stimulatory at some times and contractionary at others? The chapter frames the answer around a time-varying reference level called the natural rate of interest.

### Definition and role of the natural rate
- The natural rate of interest is the real interest rate that is neither stimulatory nor contractionary and is consistent with output at potential and stable inflation.
- The chapter notes: “The ‘natural’ part means that this is the real interest rate that is neither stimulatory nor contractionary and is consistent with output at potential and stable inflation.”
- The natural rate is typically driven by real phenomena such as technological progress, demographics, inequality, or preference shifts for safe and liquid assets.
- The natural rate is important for:
  - Gauging the stance and likely impact of monetary policy.
  - Anchoring real rates over long periods, thereby influencing the cost of borrowing and the sustainability of public debts.

### Key questions addressed
- How has the natural rate evolved in the past across different economies?
- What has driven this evolution?
- What is the outlook for these drivers and natural rates in the near and medium term?
- How will this outlook affect monetary and fiscal policies?

### Approach and methodology
- Two-pronged estimation strategy:
  - Start with a simple, data-driven model (Laubach and Williams 2003) that “lets the data speak.”
  - Move to a tighter theoretical structure (Platzer and Peruffo 2022) that imposes more restrictions but allows deeper analysis of underlying drivers.
- Compare estimates from different models for independent validation.
- Consider alternative scenarios for plausible future developments of main drivers to provide robustness and to inform monetary policy and debt sustainability analysis.

### Main findings (as stated)
- Common trends have played an important role in driving real interest rates down. The natural rate has declined over the past four decades in most advanced economies and some emerging markets. While idiosyncratic factors can explain cross-country differences, common trends underlying demographic transitions and productivity slowdowns are key to understanding the synchronized decline.
- Global drivers have also been important determinants but on balance have had a limited impact on net capital flows and corresponding natural rates in advanced and emerging market economies. High growth in emerging markets has tended to drive up interest rates in advanced economies while producing a glut of savings in emerging markets; these excess savings—seeking safe and liquid assets—have tended to flow back to advanced economies, pushing natural interest rates back down. On balance, these forces seem to have had broadly offsetting effects on capital flows and a moderate impact on natural rates over the past half-century.
- Country-specific natural rates of interest are projected to converge in the next couple of decades. Based on conservative assumptions on demographic, fiscal, and productivity developments, it is anticipated that natural rates in large emerging market economies will decline, gradually converging toward the low and steady levels expected in advanced economies.
- As inflation returns to target, the effective lower bound on interest rates may become binding again. Post-pandemic increases in interest rates could be protracted until inflation is brought back to target. Long-term forces driving the natural rate suggest that interest will eventually converge toward pre-pandemic levels in advanced economies. How close to those levels will depend on whether alternative scenarios involving persistently higher government debt and deficit or financial fragmentation materialize. Because nominal rates cannot fall far below zero (the effective lower bound constraint), this could limit central banks’ ability to respond to negative demand shocks. Debates about the appropriate level of target inflation at the effective lower bound could reemerge. Some central banks in emerging market economies may eventually need to adopt unconventional policy tools similar to those used by advanced economies in recent years.
- Despite increased fiscal space, many countries will have to consolidate. While low natural rates may ease pressure on fiscal policy, they do not negate the need for fiscal responsibility. Important government support during the pandemic has strained public accounts, requiring some budget consolidation to ensure long-term debt sustainability. Delaying action will only make required steps more drastic: larger public debt tends to crowd out private investment and erode the appeal of safe and liquid government debt.

### Trends in real rates over the long term (empirical facts)
- Ex ante and ex post measures of real interest rates across different maturities in the United States and across advanced economies share a common long-term trend: real rates have fallen steadily by about 5 percentage points over the last four decades across all maturities.
- In a cross-country comparison using three-month real rates for five advanced economies, real rates declined steadily from highs in the 1980s, and the common international component appears to have become more important over time with gradual convergence.
- A contrast between advanced and emerging market economies shows a shared trend at the start of the 2000s that decoupled later as real rates continued to decline in advanced economies but stabilized at their 2005 level in emerging markets.
- The data suggest the natural rate has likely declined in advanced economies over the past four decades, while natural rates in emerging markets have remained broadly stable over the past 20 years on average.

### Measuring the natural rate: single-country estimates
- The chapter applies the Laubach-Williams (HLW) model, built on New Keynesian relationships between supply, demand, interest rates, and prices, to estimate the natural rate as the real interest rate that returns output to potential and inflation to target once transitory shocks dissipate.
- The HLW model decomposes changes in the natural rate into:
  - A component due to changes in the long-term growth trend.
  - A component due to other factors, potentially including domestic and foreign drivers.
- Results from estimating the HLW model for six advanced economies across two five-year periods (end of the 1970s and late 2010s) indicate:
  - The natural rate of interest has declined across advanced economies in the past 40 years.
  - The magnitude of the decline is broadly similar across countries, at a little over 2 percentage points in most countries.
  - This decline in natural rates is much smaller than the overall decline in real interest rates over the same period (about 5 percentage points), which likely also reflected changes in monetary policy stance.
- Uncertainty in natural rate estimates is large:
  - The 90 percent confidence interval for the United States in the second half of the 2010s ranges from zero to about 3 percent.
  - Confidence intervals for the trend growth component are much smaller because output data are directly informative about trend growth.
- One notable result: the decline in the natural rate is similar across advanced economies despite differing trend growth components; with the exception of Japan, the natural rate dropped more than implied by changes in growth rates alone, implying forces beyond domestic growth have contributed to the decline.

_Italic line: Source: IMF staff; chapter authors Philip Barrett (co-lead), Christoffer Koch, Jean-Marc Natal (co-lead), Diaa Noureldin, and Josef Platzer; with support from Yaniv Cohen and Cynthia Nyakeri._

### 1. Canada

### 1. Canada

### Estimates of the natural rate
- Figure 2.3 and Figure 2.4 present Kalman filter and structural estimates of the natural rate for selected advanced economies, including Canada.
- Note: The ranges shown are 90 percent confidence intervals.
- Figure 2.4’s vertical axis spans from –10 to 6 (Percent), indicating the scale of contemporaneous and current estimates of real and natural rates for panels including Canada.
- The full-sample estimate labeled “Estimates based on data up to 2022:Q3” uses data up to the third quarter of 2022 to approximate the current best guess of the natural rate at each point in time.
- Contemporaneous estimates are computed by repeatedly running the model, extending the data sample by one quarter each time, and aim to approximate assessments available to policymakers at the time.

### The natural rate during the COVID-19 pandemic
- Two vintages of measures are compared: full-sample estimates (using data up to the third quarter of 2022) and contemporaneous estimates (rolling-quarter vintages).
- Early in the pandemic:
  - Contemporaneous estimates often presented a much tighter view of monetary policy than full-sample estimates.
  - The model viewed supply shocks as having a large permanent component, generating an exceptionally low natural rate and thus a tight stance for monetary policy.
  - Subsequent data revised much of the sharp early-pandemic change in the natural rate away.
  - A reasonable interpretation is that policymakers “looked through the immediate crisis” and applied judgment that delivered moderately stimulatory policy when a model without hindsight suggested a tight stance.
- Later in the pandemic:
  - Policy became looser largely through inflation eroding real policy rates rather than through a large rise in the natural rate.
  - For this later period, the red (full-sample) and blue (contemporaneous) estimates and diamonds are generally very close, implying subsequent data did not add much new information beyond contemporaneous assessments.
  - The HLW model suggests that policy was loose for a long time in some countries (see October 2022 Global Financial Stability Report reference in source).

### Multicountry estimates and international spillovers
- A key limitation of the HLW closed-economy approach is it estimates a single country at a time and cannot capture international spillovers.
- Wynne and Zhang (2018) propose a two-region empirical framework (United States and rest of the world) that allows natural rates to be affected by both domestic and foreign growth.
- Intuition: higher foreign growth raises foreign returns, requiring greater compensation for domestic investors and driving up the domestic natural rate; changes feed back between regions.
- Figure 2.5 results (United States vs. rest of the world):
  - The United States’ natural rate declined by about 2 percentage points over the past 50 years.
  - The rest of the world’s natural rate has been more stable since the mid-1970s.
  - Two offsetting international channels are identified:
    - Overseas growth (red) helped support the US natural rate.
    - “Other factors” (yellow), increasingly negative for the United States, are consistent with increased foreign demand for safe and liquid US assets depressing returns.
  - The net negative effect of international capital flows is largest for the United States in this decomposition.
- Caveats: estimation is not disciplined by current account data and large confidence bands imply high imprecision.

### Drivers of the natural rate (theory and mechanisms)
- Drivers are categorized into macroeconomic drivers (long-term) and financial drivers (short- to medium-term), though the distinction is partly artificial.
- Macroeconomic drivers:
  - Productivity growth: higher productivity growth raises the natural rate by increasing the marginal product of capital.
  - Demographics: fertility and mortality changes have complex, time-varying effects via growth, dependency ratios, and desired saving for retirement.
  - Fiscal policy: increased government borrowing can raise interest rates by requiring more saving, with effects depending on displacement of private investment.
  - Market power and labor share: ambiguous effects; depressed future production/investment tends to lower rates, but redistribution toward capital owners can raise them depending on cohort distribution of dividends.
  - Other reasons: taxation effects on consumption/saving profiles, rising inequality increasing aggregate saving, and interactions among channels.
- Financial drivers:
  - International capital flows and scarcity of safe assets: two opposing mechanisms—capital outflows to high-growth emerging markets can raise advanced economy natural rates; but a global shortage of safe liquid assets (primarily US government bonds) can lower their returns and thus the natural rate.
  - Risk aversion and leverage cycles: convenience yields on safe assets increase in stress, increasing demand for assets like US Treasurys and lowering their returns.

### A new theoretical framework (PP model) and attribution exercises
- The chapter uses a macroeconomic model (PP) based on Platzer and Peruffo (2022) that unifies many mechanisms within one framework to quantify contributions to the natural rate.
- PP model features and calibration:
  - A real macroeconomic model abstracting from nominal and financial frictions and assuming away uncertainty; suited to medium- to long-term real interest rate trends.
  - Calibrated to eight major global economies: the United States, Japan, Germany, the United Kingdom, France, China, India, and Brazil (covering about 70 percent of global GDP).
  - Country-specific calibrations use demographic developments, age-earning profiles, the share of income going to the richest 10 percent, productivity trends, retirement age, average pension replacement rates, labor share, government debt, and public expenditure.
- Model comparisons and findings:
  - Figure 2.6 compares PP structural-model estimates to HLW Kalman-filter estimates; results are strikingly similar, lending credibility to both approaches.
  - Figure 2.7 (referenced) attributes changes in the natural rate over the past decades to different fundamental forces for each of the eight countries.
  - Common forces across countries:
    - Population aging contributed negatively to the natural rate in all eight countries; effects were particularly large in China, Japan, and Germany.
    - Declines in total factor productivity (TFP) occurred in all advanced economies and sometimes explain far more than the final decline in the natural rate.
    - Fiscal policy often offset negative contributions, particularly in Japan and Brazil:
      - In Japan, public debt increased by more than 200 percent of GDP, lifting the natural rate by more than negative contributions from TFP growth or demographics.
      - In Brazil, large increases in public consumption financed by taxation explain a positive fiscal contribution; increased public debt also plays a role.
    - Net international capital flows (summarizing global spillovers) have a significant but smaller effect and operate in expected directions:
      - Largest net negative effect in the United States (consistent with stockpiling of safe assets by emerging markets outweighing capital outflows to attractive opportunities abroad).
      - In Japan, capital outflows dominate, lifting Japan’s natural rate as excess domestic savings are invested abroad.
    - The picture is more mixed in the three large emerging markets (China, India, Brazil) included in the calibration.

*Source: IMF staff synthesis of chapter content in the provided material.*

### 1. France2. Germany

### 1. France2. Germany

### The Outlook for the Natural Rate
- The chapter shifts from historical drivers to projections: what will happen to real (natural) interest rates in the future.
- Baseline projection converts assumptions about drivers into predictions using the same framework that explained past changes.

### Baseline
- Baseline assumptions:
  - Predicted demographic trends follow United Nations population projections.
  - Public debt follows World Economic Outlook (WEO) projections until 2028 (and remains constant thereafter).
  - All other drivers are assumed fixed at their 2015–19 levels.
  - In emerging markets, TFP growth is assumed to converge to the advanced economies’ average over the long term.
- Key baseline implications:
  - Natural interest rates are likely to stay close to pre-pandemic levels in advanced economies.
  - In emerging markets, a significant decline in natural rates is projected due to slowing productivity growth and aging populations.
  - Example projection: In China, a steady decline in the natural rate by about 1.5 percentage points within the next 30 years is projected, bringing it to about zero in 2050.
- Baseline assumes some segmentation between capital markets of advanced economies and emerging markets and that capital inflows/outflows remain as in 2019.

### Alternative Scenarios (illustrative deviations from baseline)
- Overall expected deviations span about 120 basis points centered on the baseline.
- Scenario highlights and quantified effects:
  - Higher government debt:
    - Allowing public debt to increase by 25 percent of GDP above the baseline by 2050 would increase demand for private savings and lift the natural rate.
    - The impact should not exceed 5 to 10 basis points for most countries.
  - Erosion of the convenience yield (advanced economies’ government debt perceived as less safe/liquid):
    - If the premium returned to pre-2000 average levels, the decline in the convenience yield over the next three decades would bring up natural rates in advanced economies (and lower corporate bond yields) by about 70 basis points.
    - Reversal of large foreign portfolio investments (illustrative): gross foreign portfolio investments in the United States increased by about 79 percent of GDP from their average level before 2000; were these flows to reverse, simulations show this could result in an increase in the natural rate of roughly 100 basis points in the United States by 2050.
  - Higher labor shares in advanced economies:
    - A return to labor shares prevailing in the mid-1970s would raise the natural rate by 6 to 19 basis points by 2050.
  - Energy transition (to achieve Paris Agreement goals by 2050):
    - For reasonable scenarios based on the October 2020 WEO, natural rates are expected to decline by 50 basis points by 2050 along a hump-shaped trajectory.
    - If large investment in low-emission capital and technology is financed through budget deficits, natural rates could temporarily climb by 30 basis points.
  - Deglobalization / trade fragmentation:
    - Effects vary by region; effects on the natural interest rate are between a 40 basis point decline and a 20 basis point increase, depending on the region.
    - For trade fragmentation specifically, effects are expected to be smaller.

### Policy Implications — Monetary Policy
- Once inflation is brought back to target, long-term forces suggest:
  - Natural rates will remain low in advanced economies or decline in emerging markets, limiting central banks’ ability to ease policy by lowering nominal interest rates.
  - Central banks may need to rely on balance sheet policy and forward guidance.
  - If deflationary dynamics take hold, economies risk becoming trapped in a low-growth, underemployment equilibrium; a larger stabilization role for fiscal policy and fiscal–monetary coordination might be necessary.
  - Reopening debate on inflation targets may be warranted.

### Policy Implications — Fiscal Policy and Debt Sustainability
- Key factor for debt sustainability: the difference between the real rate of interest (r) and the growth rate of the economy (g).
- The PP model considered the impact of fiscal policy on the natural rate through public debt issuance increasing demand for loanable funds.
- The debt sustainability analysis uses a partial equilibrium framework (Mian, Straub, and Sufi 2022 style) that:
  - Takes natural interest rate and growth projections from the PP model as given.
  - Assumes savers prefer government debt for liquidity/safety (convenience yield), but convenience yield erodes as public debt accumulates, raising government borrowing costs.
  - Uses the elasticity of the convenience yield to the debt-to-GDP ratio to identify the long-term debt-stabilizing primary balance for each level of debt.
- Uncertainty dimension:
  - Higher sensitivity of interest rates to debt lowers the debt threshold requiring primary surpluses and erodes fiscal space.
  - Robustness analysis highlights the importance of safety margins for changing market conditions and investor risk perceptions.

### Fiscal Consolidation Needs — Table 2.1 (Selected results)
- The required fiscal adjustment is the change in the primary deficit (percentage points of GDP) needed relative to the 2022 primary deficit to stabilize debt-to-GDP at long-term rates given projections for the natural rate and growth.
- Near-Term Adjustment (changes in primary deficit, percentage points of GDP):
  - United States: –3.71 (Baseline)
  - United States: –3.94 (Higher Debt)
  - United States: –3.75 (1970s Labor Share)
  - China: –7.63 (Baseline)
  - China: –7.69 (Higher Debt)
  - China: –7.63 (1970s Labor Share)
- Additional Consolidation Needed for Medium-Term Adjustment (three years):
  - United States: –0.17 (Baseline)
  - United States: –0.18 (Higher Debt)
  - United States: –0.17 (1970s Labor Share)
  - China: –0.47 (Baseline)
  - China: –0.49 (Higher Debt)
  - China: –0.47 (1970s Labor Share)
- Additional Consolidation Needed for Medium-Term Adjustment (five years):
  - United States: –0.29 (Baseline)
  - United States: –0.32 (Higher Debt)
  - United States: –0.29 (1970s Labor Share)
  - China: –0.87 (Baseline)
  - China: –0.93 (Higher Debt)
  - China: –0.87 (1970s Labor Share)

### Conclusion
- Following four decades of decline, real interest rates increased in many countries after the pandemic, largely reflecting recent monetary tightening.
- The chapter argues the increase in real rates is likely temporary; when inflation is controlled, advanced economies’ central banks are likely to ease policy and bring real rates back toward pre-pandemic levels.
- In large emerging markets, conservative projections of demographic and productivity trends suggest gradual convergence toward advanced economies’ real interest rates.
- Structural policies that boost potential growth and diminish inequalities would act against the secular trends toward lower natural rates.

*Source: IMF staff calculations and chapter content.*

### CHAPTER 2

### CHAPTER 2

### Macro policy context and implications
- The “effective lower bound” constraint on interest rates and “low (interest rates) for long” are likely to resurface.
- Unconventional policies through active management of central bank balance sheets and forward guidance may become standard stabilization tools, even in emerging markets.
- Debates about the appropriate level of inflation target may reemerge as countries weigh the social cost of higher inflation against the constraint of ineffective stabilization due to the effective lower bound.
- Permanently lower real interest rates increase fiscal space—all else equal—and allow fiscal authorities to take a more active role in stabilizing the economy, provided fiscal sustainability is ensured (Chapter 2 of the April 2020 WEO).
- Clarifying the scope and responsibilities of fiscal and monetary authorities is crucial to avoid long-term damage to the credibility of central banks.

### Box 2.1 — The Natural Rate of Interest and the Green Transition (policy design and participation)
- Benchmark: a comprehensive, global policy package intended to achieve net zero emissions by 2050, simulated with the G-Cubed model.
- Carbon tax path (varies by country): start between "$6 and $20 a metric ton of CO2", reach "$40 a ton in 2030" and between "$40 and $150 a ton in 2050".
- Revenue recycling in the budget-neutral package: "25 percent recycled toward social transfers, up to 70 percent for green public infrastructure investment, and the rest as subsidies to renewable energy sectors" (policy is budget-neutral).
- Simulations assume no direct productivity gains from green public investment (conservative approach).
Findings from simulations:
- Carbon taxes acting alone depress overall investment and hence r* because carbon taxes increase the overall cost of energy, a complement in production to physical capital.
- Public investment in green infrastructure and subsidies to renewable energy positively affect investment and push up r*.
- Climate mitigation that avoids climate-change-related damages can boost productivity growth relative to a business-as-usual baseline and raise r*.
- Net impact on r* depends on the associated overall fiscal impulse:
  - A budget-neutral package depresses r* along the entire transition path in the simulation.
  - A temporary deficit-financed and front-loaded green investment push can increase r* because fiscal stimulus raises demand for private savings.
- International participation matters:
  - Partial participation (only top five emitters or only advanced economies) leads to a significantly more muted impact on r* compared with global participation.
- Long run: r* would converge to its pre-climate-policy steady state as economies become greener and climate policy applies to a shrinking share of economic activity.

### Box 2.2 — Geoeconomic fragmentation (trade and financial fragmentation scenarios)
- Modeling framework: IMF’s Global Integrated Monetary and Fiscal (GIMF) Model with value-chain modifications.
Trade fragmentation scenario (nontariff trade barriers increase by 50 percent over 10 years between US bloc and China bloc):
- Trade and output effects:
  - Global trade falls by "(–19 percent)" and output falls by "(–6 percent)" in the scenario summary.
  - Real investment in the China bloc declines the most owing to reshoring.
- Price and saving channels:
  - Import prices for consumption goods increase by "about 5 percent to 25 percent depending on the region".
  - Higher import prices reduce saving (via increased consumption prices and reduced output), which tends to push up the natural rate.
- Investment channels:
  - Higher input prices lower profitability and depress investment demand.
  - Higher relative price of investment goods (their larger import share) increases demand for loanable funds.
- Net effects on real interest rates (10-year averages / after 10 years):
  - Real interest rates fall by "about 30 basis points" in the China bloc as investment demand declines more than saving does.
  - In the United States, lower saving (raising r*) and lower investment (reducing r*) broadly balance, leaving modest net change.
  - In the nonaligned bloc, investment demand declines by less than desired saving, raising the real interest rate by "about 10 basis points".
Financial fragmentation scenario (China bloc reduces exposure to US Treasury bonds; modeled as a permanent 100 basis point premium on one bloc’s assets held by the other):
- Capital flows and interest rate effects after 10 years:
  - China bloc domestic interest rate falls by "40 basis points".
  - US bloc interest rate increases by "20 basis points".
  - US bloc net foreign asset position improves by "10 percent of GDP".
  - Nonaligned countries experience slight net capital inflows from the China bloc, reducing their interest rates by "about 10 basis points".
- Extreme fragmentation would lead regional natural rates to converge to levels reflecting only domestic drivers such as demographics and productivity.

### Box 2.3 — Spillovers to emerging market and developing economies (EMDEs)
- Focus: short-term deposit rates adjusted for ex post realized inflation (quarterly data Q1 2020 to Q4 2022, coverage uneven).
- Method: contribution of the US natural rate to EMDEs’ individual forecast error variance decomposition based on bivariate VARs; selection required cointegration with the US rate.
Key empirical findings:
- Horizon dependence:
  - At business cycle horizons of less than five years, domestic real rates dominate EMDE real rate dynamics.
  - At horizons beyond a decade, spillover from the US natural rate matters as much as domestic factors.
- Cross-country heterogeneity:
  - Larger spillovers from US natural rates for East Asian and Latin American countries.
  - In large EMDEs such as China and India, "about 30 percent" of real rate variation is explained by US natural rates after a decade.
  - After two decades, spillovers are somewhat stronger in China than in India.
  - African countries such as Cameroon, Côte d’Ivoire, and Uganda show minor spillovers, "less than a 10 percent" contribution from US natural rate spillovers.
- Role of capital account openness (de facto openness measured by IIPGDP):
  - The effect of capital account openness becomes significant gradually after about a decade.
  - Quantitative estimates:
    - A "1 percentage point" increase in the gross international investment position as a share of GDP raises the importance of the US natural rate in explaining EMDEs’ real interest rate movements by "half a percentage point" after a decade and by "0.9 percentage point" after two decades.
    - Brazil example (IIPGDP "about 40 percent"): "20 percent" of the forecast error variance decomposition of Brazilian real interest rates is attributable to US spillovers after a decade, and "about 36 percent" after two decades.
- Implication: sizable but low-frequency spillovers from US natural rates to EMDEs, with the strength of spillovers increasing with capital account openness and at longer horizons.

*International Monetary Fund | April 2023 — CHAPTER 2*

### References

### References

### Key findings on public debt dynamics and policy effectiveness
- Public debt as a ratio to GDP approached 100 percent in 2020 and is expected to remain above pre-pandemic levels for about half of the world.
- High public debt ratios pose growing challenges given tightening global financial conditions, weak growth prospects, and a stronger US dollar.
- The recent rise in sovereign debt holdings of domestic financial institutions, particularly in emerging markets, has exacerbated costs of high public debt by limiting lending to the private sector and aggravating sovereign-bank feedback loop risks.

### Main conclusions on reducing debt-to-GDP ratios
- Adequately timed and appropriately designed fiscal consolidations have a high probability of durably reducing debt ratios.
  - The average size of primary balance consolidations that reduced debt ratios in the past is about 0.4 percentage point of GDP.
  - Such consolidations lowered the average debt ratio by 0.7 percentage point in the first year and up to 2.1 percentage points after five years.
  - About half of the observed decreases in debt ratios are driven by suitably tailored consolidations.
- The effectiveness of fiscal consolidation improves under specific conditions:
  - Probability of success improves from the baseline (average) of about 50 percent to more than 75 percent when:
    - There is a domestic or global expansion and global risk aversion and financial volatility are low.
    - The scope for “crowding out” effects is high (cases with initial high public debt and low private credit).
    - Consolidation is driven more by expenditure reductions than by revenue increases (in advanced economies).
- On average, however, fiscal consolidation has a negligible effect on debt ratios because:
  - Fiscal consolidation tends to slow GDP growth.
  - Realizations of contingent liabilities (for example, transfers to state-owned enterprises) and unexpected exchange rate depreciations can offset debt reduction efforts.
- Debt restructuring is typically a last resort; in emerging market economies and low-income countries it can significantly reduce debt ratios:
  - Restructuring can reduce debt ratios by an average of 3.4 percentage points (where most restructurings occur).
  - Effective debt reduction in distress typically requires a comprehensive approach combining significant debt restructuring, fiscal consolidation, and policies to support economic growth, with coordination among creditors being essential.
- Economic growth and inflation have historically contributed to reducing debt ratios.

### Research scope, data, and questions addressed
- The chapter uses an up-to-date data set of fiscal aggregates and a comprehensive set of restructuring events for advanced economies and emerging market economies over the past two decades; low-income countries are included where information is available.
- The chapter uses updated data on historical episodes of fiscal consolidation during 1978–2019 that identify fiscal policy actions aimed at reducing deficits.
- Core questions examined include:
  - How have countries reduced public debt ratios in the past and what were contributions of growth and inflation?
  - How effective are different policy approaches in durably reducing public debt ratios over horizons of five years and beyond?
  - What are the short- and medium-term (one to five years) effects of fiscal consolidation and debt restructuring on debt ratios, and how do they interact?
  - What does historical experience suggest for countries dealing with high debt today?

### Quantitative sample and illustrative indicators
- Sample for public debt trends: balanced panel of 32 advanced economies, 45 emerging market economies, and 12 low-income countries.
- Reported aggregates and time markers:
  - 2020: global average debt ratio approached 100 percent.
  - Average primary balance consolidation associated with debt reduction: about 0.4 percentage point of GDP.
  - Average debt ratio reduction: 0.7 percentage point in the first year; up to 2.1 percentage points after five years.
  - Baseline probability of success for consolidation: about 50 percent; conditional probability: more than 75 percent.
  - Average debt reduction from restructuring in EMs and LICs: 3.4 percentage points.

*International Monetary Fund | April 2023*

### CHAPTER 3 COMINg DOWN TO EARTh: hOW TO T ACKLE SOARINg PUbLIC DEbT

### CHAPTER 3 COMINg DOWN TO EARTh: hOW TO T ACKLE SOARINg PUbLIC DEbT

### Major findings and summary conclusions
- Restructurings have historically had larger effects on debt ratios, especially in the short term, when they were (1) executed through face value reduction and (2) part of coordinated and large-scale initiatives for debt reductions (for example, the Heavily Indebted Poor Countries [HIPC] Initiative and Multilateral Debt Relief Initiative [MDRI]).
- Debt restructuring is a complex process involving burden sharing among residents, domestic creditors, and foreign creditors; it can have reputational costs, affect interest rates and future market access, and have internal distributional consequences.
- Economic growth and inflation play an important role in reducing debt ratios: growth reduces debt ratios through effects on nominal GDP and because countries on average consolidate (run higher primary balances) during good times.
- For moderate and gradual debt reduction, well-designed fiscal consolidations are recommended, particularly when economies are growing faster and external conditions are favorable; effects are reinforced by growth-enhancing structural reforms and strong institutional frameworks.
- For more substantial or rapid debt reduction, bold policy actions that may include debt restructuring can be necessary; lower debt ratios are achieved when restructuring is deep enough and implemented together with comprehensive policy packages including IMF-supported programs.
- Improving coordination mechanisms (for example, enhancing the G20 Common Framework with greater predictability, earlier engagement, a payment standstill, and further clarification on comparability of treatment) can increase the success of restructurings in reducing debt ratios.
- Prioritizing debt management and transparency in advance can reduce the need for restructuring and help manage debt distress.
- Although high inflation can reduce debt ratios, it is not a desirable policy tool because high inflation can lead to losses for sovereign debt holders and damage the credibility of institutions such as central banks.
- Durable debt reduction depends on strong institutional frameworks that prevent “below the line” operations and ensure countries build buffers and reduce debt during good times.

*International Monetary Fund | April 2023*

### Macroeconomic drivers of the debt-to-GDP ratio
- Average features of debt reduction episodes:
  - On average, a debt ratio reduction episode lasts five years.
  - The magnitude of the decline in the debt ratio is, on average, 3, 5, and 10 percentage points a year in advanced economies, emerging market economies, and low-income countries, respectively.
- Decomposition insights (Figure 3.2):
  - Primary balance surpluses are the most important driver in advanced economies (red bars).
  - Real GDP growth is the next most important driver in advanced economies (dark blue bars).
  - Nominal interest expense always contributes positively to the change in debt ratios (dark yellow bars).
  - Real GDP growth and inflation play a relatively bigger role in reducing debt ratios in emerging market economies and low-income countries (dark and light blue bars).
- Inflation channels:
  - High inflation affects debt ratios through higher nominal GDP and higher nominal interest rates.
  - Higher expected inflation can translate into higher nominal interest expenses and can cancel out favorable effects; unexpected inflation affects debt ratios mainly via higher nominal GDP.
  - The April 2023 Fiscal Monitor finds that positive inflation surprises significantly reduce debt ratios.
- Evidence consistent with expected-inflation effects:
  - Nominal effective interest rates in emerging market economies and low-income countries remain low relative to inflation (see Table 3.1), possibly due to concessional borrowing or financial repression.
  - Higher expected inflation and higher policy and market rates feed slowly into effective interest costs of debt, likely because of high average maturity of sovereign debt (seven years).

Table 3.1. Average Nominal Effective Interest Rate and Inflation during Reduction Episodes
- Advanced Economies: 5.63.0
- Emerging Market Economies: 5.29.0
- Low-Income Countries: 2.610.0

Note: Table values are presented exactly as in the chapter.

### Role of fiscal consolidation, growth, and inflation
- Stylized facts and empirical results:
  - Only 52 percent of increases in primary balance are accompanied by a decrease in debt ratios.
  - A broad range of econometric methods confirm that fiscal consolidations do not reduce debt ratios, on average.
  - Augmented inverse-probability-weighted (AIPW) estimation and narrative-shock approaches show the average narrative fiscal consolidation does not have a statistically significant impact on the debt ratio (Figure 3.3).
- Conditional analysis (SVAR approach):
  - A structural vector autoregression (SVAR) with sign restrictions is used to study conditions under which consolidations reduce debt ratios.
  - The SVAR also suggests consolidations do not reduce debt ratios on average.
  - The primary balance shock is split into two orthogonal components: a successful shock after which the debt ratio declines, and an unsuccessful shock after which the debt ratio rises.
- Historical decomposition results (Table 3.3):
  - Higher GDP growth (demand and supply shocks together) explains about one-third of observed reductions in debt ratios.
  - About 40 percent of observed debt ratio reductions in both advanced and emerging market economies are explained by primary balance shocks, with a relatively even split between successful and unsuccessful primary balance shocks.

Table 3.3. Median Contribution during Debt Reductions (Percent)
- Demand Shock: AEs 19 EMs 12
- Supply Shock: AEs 21 EMs 13
- Successful Primary Balance Shock: AEs 19 EMs 21
- Unsuccessful Primary Balance Shock: AEs 16 EMs 22

(Note: AEs = advanced economies; EMs = emerging market economies.)

- Characteristics of successful versus unsuccessful consolidations:
  - Successful consolidations entail smaller declines in growth: a 0.5 percent reduction on impact versus a 1.3 percent reduction in unsuccessful consolidations.
  - The key difference between successful and unsuccessful consolidations is movements in debt: in unsuccessful cases GDP falls but the debt-to-GDP ratio increases twice as much as the fall in GDP.
  - The response of inflation to consolidation shocks is positive; revenue (tax increase) components and exchange rate depreciation associated with consolidations can push inflation up.

### Debt restructuring: effects and implementation considerations
- Restructurings historically have larger short-term effects when implemented via face value reduction and in coordinated large-scale initiatives (HIPC, MDRI).
- Case studies highlight complexity: burden sharing, reputational costs, interest rate and market access effects, and internal distributional consequences make restructuring typically part of a broader policy package and often a last resort.
- Lower debt ratios are achieved when restructuring is deep enough and implemented with comprehensive policy packages including IMF-supported programs.
- Success factors for restructuring:
  - Mechanisms promoting coordination and confidence among creditors and debtors.
  - Improvements to the Group of Twenty (G20) Common Framework: greater predictability, earlier engagement, a payment standstill, and further clarification on comparability of treatment.
  - Prior debt management and transparency to reduce the need for restructuring.

### Policy lessons and implications
- For moderate, gradual debt reduction: implement well-designed fiscal consolidations when economies are growing and external conditions favorable; pair fiscal adjustment with growth-enhancing reforms and strong institutions.
- For substantial or rapid debt reduction: consider bold policy actions that may include restructuring; fiscal consolidation may still be necessary to regain market confidence.
- Avoid relying on high inflation as a deliberate debt-reduction tool because of balance-sheet losses for sovereign debt holders and institutional credibility risks.
- Strong institutional frameworks are essential to prevent below-the-line operations and to ensure countries build buffers and reduce debt during good times.

*International Monetary Fund | April 2023*

### 1. GDP Growth

### 1. GDP Growth

### Impulse Response Overview (SVAR results, 21 advanced economies, 1981–2019)
- Displayed impulse responses are inverse variance weighted means across countries from a Bayesian vector autoregression estimated country by country with two lags at annual frequency.
- Shaded areas represent the 16th–84th percentile range of the posterior distribution.
- X-axis denotes horizon in years.

Key impulse response axes and ranges shown in figures:
- GDP Growth (Percent): –2.0, –1.5, –1.0, –0.5, 0.0, 0.5, 0,1,2,3,4,5 (horizon)
- Revenue Growth (Percent): –1.2, –0.6, 0.0, 0.6, 1.2, 1.8, 0,1,2,3,4,5 (horizon)
- Primary Balance to GDP (Percentage points, first difference): –0.4, 0.0, 0.4, 0.8, 1.2, 0,1,2,3,4,5 (horizon)
- Debt to GDP (Percentage points, first difference): –2, –1, 0, 1, 2, 3, 4, 0,1,2,3,4,5 (horizon)
- Nominal Effective Interest Rate (Percent, first difference): –0.3, –0.2, –0.1, 0.0, 0.1, 0.2, 0.3, 0.4, 0,1,2,3,4,5 (horizon)
- Inflation (Percent, first difference): –0.6, –0.4, –0.2, 0.0, 0.2, 0.4, 0.6, 0.8, 0,1,2,3,4,5 (horizon)

Sources for impulse-response inputs: Canova and Ferroni (2022); IMF, Global Debt Database; IMF, Historical Public Debt Database; and IMF staff calculations.

### Fiscal Consolidation: effects and characteristics
- The primary balance shock is scaled to 1 percentage point of GDP on impact on average.
- Successful fiscal consolidations:
  - Are balanced between spending cuts and tax or revenue increases in advanced economies.
  - Tend to allow higher inflation on impact relative to unsuccessful consolidations, with the impact on nominal effective interest rates statistically indistinguishable from zero for successful consolidations.
  - See inflation contribute significantly—about half a percentage point—to the reduction in the debt ratio.
  - Durably reduce debt ratios beyond a five-year horizon.
- Average consolidation shock in the data:
  - Improves the primary balance by 0.4 percentage point of GDP (mostly on impact).
  - Reduces debt ratios by 0.7 percentage point by the first year and stabilizes at a 2.1 percentage point reduction by year five and beyond.
- Unsuccessful consolidations:
  - Are biased toward revenue increases and involve fewer spending cuts in advanced economies.
  - Can fail to reduce debt ratios if countries conduct below-the-line operations (examples cited: transfers to state-owned enterprises in Mexico (2016), clearance of arrears in Greece (2016), contingent liabilities in Italy (2013)).

### Conditions increasing probability that consolidations reduce debt ratios
- Consolidations are more likely to reduce debt ratios:
  - During good times (domestic and global booms).
  - When financial tightening is less and volatility/uncertainty (VIX) is lower.
  - When initial public-debt-to-GDP ratio is high and initial private-credit-to-GDP ratio is low.
- Quantitative illustration (multivariate standardized logit regression; baseline unconditional success probability = 51 percent):
  - Domestic output gap, world output gap, lower VIX, higher debt-to-GDP, and lower private credit to GDP increase the probability of successful consolidation.
  - Example computation noted: when global and domestic output gaps are one standard deviation above mean and the VIX is one standard deviation below, the probability increases from a baseline of 51 to 75 percent (calculation ~=51+6.1+9.1+9.9 as noted in the text).

### Debt Restructuring: definition, stylized facts, and magnitudes
- Definition: Public debt restructuring is a “debt distress” event in which the terms of contractual payments of some outstanding government instruments are renegotiated, typically with a net present value loss for the creditor.
- Restructuring dimensions:
  - Creditor type: official (Paris Club, non–Paris Club G20, others) or private (external or domestic).
  - Timing: preemptive (before missed payments) or postdefault.
  - Implementation form: face value reduction (immediate stock reduction) or cash flow relief with no face value reduction (maturity extension, coupon reduction).
- Database summary (1950–2021, 709 events across 115 countries):
  - Almost all events in emerging market economies and low-income countries.
  - Restructurings often involve cash flow relief with no face value reduction.
  - Restructurings tend to be preemptive rather than postdefault.
  - Most frequently involve official creditors, especially in low-income countries.
  - Restructurings with domestic creditors are rare and less likely to involve face value reduction; when they do, reductions tend to be shallower.

Table 3.4 summary statistics (sample includes 310 restructuring events in emerging market economies and 396 in low-income countries from 1950 to 2021):
- Treatment:
  - Cash flow relief without face value reduction: Emerging Market Economies 85.8, Low-Income Countries 73.5
  - Face value reduction: Emerging Market Economies 14.2, Low-Income Countries 26.5
- Timing:
  - Preemptive: Emerging Market Economies 58.4, Low-Income Countries 54.3
  - Postdefault: Emerging Market Economies 21.6, Low-Income Countries 31.1
  - Both + unidentified: Emerging Market Economies 20.0, Low-Income Countries 14.6
- Creditor Type:
  - Paris Club: Emerging Market Economies 48.1, Low-Income Countries 73.5
  - China: Emerging Market Economies 8.4, Low-Income Countries 5.6
  - Private external: Emerging Market Economies 24.8, Low-Income Countries 10.1
  - Private domestic: Emerging Market Economies 6.8, Low-Income Countries 4.5
  - Joint: Emerging Market Economies 11.9, Low-Income Countries 6.3

- Fiscal consolidations precede restructuring:
  - In the sample with available primary balance data, 60 percent of debt restructuring events are preceded by an increase in the primary-balance-to-GDP ratio.
- Debt-to-GDP reductions during restructuring:
  - During restructuring events, decline in debt ratios is larger:
    - Emerging market economies: 13 percentage points with restructuring versus about 4 percentage points without restructuring.
    - Low-income countries: 18 percentage points with restructuring versus about 8 percentage points without restructuring.
  - Inflation contributes more to debt reduction in episodes with restructuring (often coinciding with crises, capital outflows, exchange rate depreciations, higher inflation).
- Historical pattern and risk:
  - Waves of restructurings followed debt ratio surges in the 1980s and early 2000s.
  - The share of countries with surging debt ratios has been on the rise since the global financial crisis.
  - No recent large wave (to date) possibly due to low interest rates and ease of financing; exceptions include 2020–2021 under the G20 Debt Service Suspension Initiative (DSSI).
  - Changing creditor composition, collective action clauses, and G20 Common Framework could alter future restructuring processes.

### Estimated effects of restructuring (AIPW estimator results)
- Method: AIPW estimator accounts for nonrandom nature of restructuring events by estimating probability of entering restructuring and reweighting observations in outcome model.
- Main findings for emerging market economies and low-income countries:
  - Average debt ratios decrease by 3.4 percentage points in the first year and 8 percentage points within five years of restructuring.
  - Effects are heightened when restructuring is accompanied by fiscal consolidation (two-thirds of restructuring events in the sample were accompanied by fiscal consolidation).
  - The joint effect of restructuring and fiscal consolidation grows over time, indicating complementarity.
- Heterogeneity in outcomes:
  - Restructurings under HIPC or MDRI programs more successfully reduced debt ratios than the typical restructuring, both on impact and over longer horizons (characteristics: coordination among creditors, deep face value reductions, IMF-supported programs).
  - Restructuring events with face value reductions have a greater impact on the debt-to-GDP ratio, with much of the effect visible in the first year.
- Caveats:
  - HIPC Initiative and MDRI were one-off initiatives.
  - Face value reductions occur more frequently when the initial debt ratio is high (average debt ratios one year preceding event with face value reductions = 90 and without = 75 percent).
  - About half of restructuring events with face value reduction happened under the HIPC Initiative; stronger effect of face value reductions on debt ratios is robust to excluding HIPC events.

### Contribution decomposition during reduction episodes
- Figure 3.7 notes:
  - The unbalanced panel covers 84 emerging market economies and 54 low-income countries.
  - Debt restructuring in the figure corresponds only to contributions of face value reduction; contribution of cash flow relief (maturity extension, coupon reduction) would be included in contributions of primary balance and interest expense.
  - Sample of face value reductions consists of restructurings by private external creditors, domestic private creditors (1999–2020), and official Paris Club creditors.

_Italic: Sources: Canova and Ferroni (2022); Asonuma, Niepelt, and Ranciere (2023); Asonuma and Trebesch (2016); Asonuma and Wright (2022); Cheng, Díaz-Cassou, and Erce (2018); Cruces and Trebesch (2013); Horn, Reinhart, and Trebesch (2022); IMF (2013, 2016, 2017, 2021); IMF, Global Debt Database; IMF, Historical Public Debt Database; Mauro and others (2013); and IMF staff calculations._

### 1. Restructuring Joint with Consolidation

### 1. Restructuring Joint with Consolidation

### Key findings
- Debt restructuring has a large and long-lasting impact on the debt ratio and is more effective when combined with fiscal consolidation and when implemented through large-scale initiatives with coordination mechanisms across creditors.
- Sample composition (as reported): "Sample consists of 11
1 emerging market and developing economies from 1987 to 2021."
- Average magnitudes and effects:
  - "The average face value reduction in the debt ratio is about 4.2 percent of GDP per year that the restructuring event lasts."
  - "The average successful fiscal consolidation reduces the primary balance by only 0.4 percent of GDP."
  - "A 1 percentage point face value reduction can decrease the debt ratio by, on average, 1.9 percentage points, exceeding the 'mechanical' impact on the debt ratio."
  - Average observed restructuring effects (as summarized in the chapter): "The average observed restructuring reduces debt ratios by 3.4 percentage points in the first year and, cumulatively, 8.0 percentage points after five years."
- Table 3.6 (Impact of Restructuring and Consolidation, Percentage points):
  - Restructuring (with FVR): Size (FVR/Consolidation) = 4.2; ATE 1st Year = −7.9; ATE 5th Year = −11.4.
  - Successful Consolidations: Size = 0.4; ATE 1st Year = −0.8; ATE 5th Year = −2.5.

### Comparing magnitudes and interpretation
- Per-unit comparison:
  - Dividing estimated average treatment effect by treatment size suggests that after one year, the impact of a successful fiscal consolidation is comparable to that of debt restructuring with face value reduction per "unit" of treatment. After five years, fiscal consolidations are on average more effective by this metric.
- Caveats:
  - Fiscal consolidations and restructurings occur under different circumstances; types of restructuring differ by macro conditions, type of debt, creditor preferences, creditor structure, and other unobserved variables that complicate econometric comparisons.
  - Historical events have rarely included "deep enough" preemptive restructurings; quantifying the impact of deep preemptive restructuring is difficult due to their rarity.

### Case studies and granular lessons
- Five specific case studies reviewed: (1) Cyprus, 2014–19; (2) Jamaica, 2010–18; (3) Seychelles, 2009–15; (4) Belize, 2012–19; and (5) Mozambique, 2016–19.
- Summary of case outcomes (Table 3.7 format condensed):
  - Success in reducing public-debt-to-GDP ratios: Seychelles, 2009–15; Jamaica, 2010–18; Cyprus, 2014–19.
  - Debt remained elevated or increased: Belize, 2012–19; Mozambique, 2016–19.
  - Types of creditors and treatments varied:
    - Seychelles: External private/official creditors; face value reduction and cash flow relief.
    - Jamaica: Domestic creditors; cash flow relief with no face value reduction (deep cash flow relief).
    - Cyprus: Domestic creditors; cash flow relief with no face value reduction.
    - Belize and Mozambique: External private creditors; primarily cash flow relief with no face value reduction (and in Mozambique a small face value reduction in one episode).
- Drivers and outcomes:
  - In successful cases, debt ratios declined substantially in Jamaica and Seychelles and modestly in Cyprus.
  - Seychelles: debt ratio reached 180 percent in 2008 and declined to 84 percent in 2010 immediately after debt restructurings with large face value reductions; prudent fiscal policy and high inflation helped sustain the reduction.
  - Jamaica: cash flow relief was deep and saved, with debt-to-GDP declining to 100 percent by 2018; high inflation played an important role.
  - Cyprus: modest cash flow relief; debt-to-GDP declined to about 90 percent by 2019; recovery in GDP growth contributed.
  - Growth and inflation contributions (reported figures):
    - Economic growth contributed "by more than 20 percentage points in both Cyprus and Seychelles and by 7 percentage points in Jamaica."
    - "Inflation also played an important role, contributing to the reduction by 50 percentage points in Seychelles and by 70 percentage points in Jamaica, though the positive contribution of nominal interest expenses offset the impact on debt—partly in Seychelles and completely in Jamaica."
  - Belize and Mozambique: restructurings executed through cash flow relief with no face value reduction; debt service relief was used to support expansionary public expenditure; Mozambique experienced transfers to state-owned enterprises that increased the debt ratio by 13.8 percentage points.

### Lessons on design and success factors
- Restructurings need to be deep to improve chances of success, regardless of whether implemented via face value reductions or cash flow relief.
- Fiscal consolidation is critical even when significant face value reductions occur; it helps sustain debt reduction and can persuade external creditors to accept nominal reductions.
- Preemptive restructurings executed through deep cash flow relief can succeed (example: Jamaica) but have been rare historically.
- Coordination mechanisms across creditors, early engagement, a debt service payment standstill during negotiations, and clarity on comparability of treatment can improve restructuring outcomes.
- Debt management and transparency remain priorities to manage risks and reduce the need for restructuring.

### Conclusions and policy implications
- When moderate and gradual debt reduction is feasible, well-designed fiscal consolidation (for example, growth friendly and in advanced economies often more expenditure- than revenue-based measures) combined with growth-friendly structural reforms has a high probability of durably reducing debt ratios.
  - Empirical estimate for typical successful consolidation: "The average successful fiscal consolidation in the data (equal to 0.4 percentage point of GDP) reduces debt ratios by 0.7 percentage point during its first year and, cumulatively, by up to 2.1 percentage points after five years."
- For countries facing high risks of debt distress or increased rollover risks, substantial or rapid debt reduction may be the only viable option; these countries will require sustained and complementary policy actions:
  - Fiscal consolidation to regain market confidence and macroeconomic stability.
  - Timely consideration of debt restructuring, which needs to be deep to succeed in reducing debt ratios.
  - Designing macroeconomic programs that include fiscal, structural, and potential restructuring measures from the outset, rather than treating restructuring as a last resort.
- Structural reforms and growth are essential complements: "Both economic growth and inflation play an important role in reducing debt ratios."
- Improvements to the G20 Common Framework could help: greater predictability on steps in the process, earlier engagement with official and private creditors, a debt service payment standstill during negotiations, and further clarification on comparability of treatment.
- Caution on inflation: although inflation has been significant historically in reducing debt ratios in some episodes, "this does not suggest that high inflation is a desirable tool" due to risks of entrenched high inflation expectations and higher future debt issuance burdens.

*Source: IMF staff compilation.*

### CHAPTER 3 COMINg DOWN TO EARTh: hOW TO T ACKLE SOARINg PUbLIC DEbT

### CHAPTER 3 COMINg DOWN TO EARTh: hOW TO T ACKLE SOARINg PUbLIC DEbT

### Institutions and durable debt reduction
- Strong institutions are crucial to durable debt reduction; robust fiscal and monetary frameworks can prevent operations that undermine debt reduction efforts and help countries benefit from global forces pushing down the natural interest rate.
- A credible medium-term fiscal framework can help countries manage high debt as they undertake fiscal adjustments to rebuild buffers (Gaspar, Obstfeld, and Sahay 2016; Caselli and others 2022).
- A medium-term debt management strategy can provide a structured approach for governments to evaluate costs and risks associated with financing options.

### Market reforms and public debt sustainability (Box 3.1)
- Empirical evidence for 62 emerging market and developing economies during 1970–2014:
  - A one-standard-deviation increase in an indicator of reforms is estimated to lead to a 0.6 percent increase in real GDP over five years.
  - The same shock is estimated to lead to a medium-term reduction in the ratio of public debt to GDP of 1.5 percentage points.
- Mechanisms and offsets:
  - Reforms are associated with increased revenues and lower sovereign spreads.
  - Reforms are also associated with higher public consumption, with only a small and temporary improvement in the overall fiscal balance.
  - Countries with a more efficient value-added tax tend to experience greater fiscal gains from reforms.
- Policy guidance:
  - To protect fiscal gains from reforms, direct additional revenue toward growth-friendly public investments.
  - Enhance the tax base through tax collection efficiency.

### Monetary and fiscal interactions and debt servicing (Box 3.2)
- Response of effective rate (interest expense divided by previous period’s debt stock) to inflation:
  - An increase in consumer price inflation of 1 percentage point lowers the effective real rate by about 0.5 percentage point on impact and does not lead to a higher effective real rate across the horizon.
- Response of effective rate to long-term real rates:
  - An increase in the real spot market rate for a 10-year government bond of 100 basis points is associated with an increase in the effective real rate of only about 20 bps, on average, on impact.
  - Among emerging market and developing economies with weaker institutional frameworks and those without an inflation-targeting central bank, the point estimate increases to about 60 bps.
- Interpretations and risks:
  - A rise in spot rates feeds into effective rates far less than one to one.
  - Factors contributing to muted pass-through include increases in average maturity of outstanding debt and central bank credibility anchoring inflation expectations.
  - The share of central government debt maturing in 12 months or less has increased over the past five years in both advanced and emerging market and developing economies, raising rollover risk.
  - Persistent inflationary pressures could produce a “high for long” interest rate environment; over a longer time frame, equilibrium real interest rates are expected to remain low on account of structural forces (see Chapter 2), helping keep real debt servicing costs in check.

### Geopolitical fragmentation and FDI (introductory material from Chapter 4 included in Chapter 3 file)
- Recent trends:
  - Global foreign direct investment declined from 3.3 percent of GDP in the 2000s to 1.3 percent between 2018 and 2022.
- Drivers and policy context:
  - Rising geopolitical tensions, policy-driven reversals of integration (geoeconomic fragmentation), and supply-chain concerns have increased firms’ interest in reshoring and friend-shoring.
  - Large policy initiatives (for example, semiconductor and climate-related acts) and investment-screening measures motivated by national security are prompting firms to reconfigure supply chains.
- Potential economic effects:
  - Reconfiguration can strengthen domestic security and may increase diversification if it reduces concentration in a small number of foreign suppliers, but where home bias is strong, reshoring or friend-shoring will likely reduce diversification and increase vulnerability to macroeconomic shocks.
  - In the absence of multilateral agreements, multilateral consultations and processes are required to mitigate spillovers of unilateral policies.
- Policy options for countries:
  - Promote private sector development to reduce vulnerability.
  - Attract diverted investment by undertaking structural reforms and improving infrastructure.

*Source: CHAPTER 3 COMINg DOWN TO EARTh: hOW TO T ACKLE SOARINg PUbLIC DEbT, International Monetary Fund | April 2023*

### CHAPTER 4 GEOECONOMIC FRAGMENTATION AND FOREIGN DIRECT INvEsTMENT

### CHAPTER 4 GEOECONOMIC FRAGMENTATION AND FOREIGN DIRECT INvEsTMENT

### Overview and motivation
- FDI accounts for about 12 percent of domestic capital stock globally and is associated with knowledge transfer to domestic firms and economic growth, especially in emerging market and developing economies.
- The chapter investigates (1) evidence of reallocation of FDI across countries indicating increased fragmentation, and (2) whether geopolitical factors help explain bilateral FDI flows (deeper integration with friends, reduced reliance on foes).
- A multidimensional index of countries’ vulnerability to FDI relocation is developed, combining:
  - geopolitical distance between source and host countries,
  - share of strategic sector investment in total FDI inflows,
  - degree of market power enjoyed by the host country.

### Data and measurement
- Main data source: investment-level data on new (greenfield) FDI from fDi Markets, covering about 300,000 investments from the first quarter of 2003 to the fourth quarter of 2022.
- The chapter uses the number of greenfield foreign direct investments as the measure of FDI (investment values are often estimated; robustness checks use values).
- “Strategic” sectors are defined at the three-digit industry level (see Online Annex 4.1 for details in the source).

### Early signs of FDI fragmentation and recent trends
- Recent patterns point to the emergence of FDI fragmentation, with divergent post-pandemic outcomes across regions and sectors.
- Key empirical observations:
  - The flow of strategic FDI to Asian countries started to decline in 2019 and recovered only mildly; by the fourth quarter of 2022 strategic FDI to Europe was about twice that going to Asian countries.
  - Foreign investment in R&D and in specific strategic industries, such as the semiconductor industry, shows an even stronger divergence, with less recovery of FDI to China.
  - FDI declined in the post-pandemic period (2020:Q2 to 2022:Q4) by almost 20 percent compared to the pre-pandemic post–global financial crisis average.
  - Asia became less relevant both as a source and host, losing market share vis-à-vis almost all other regions; FDI to and from China declined by even more than the Asian average.
  - Some regions (for example, the US and emerging Europe) saw greenfield FDI decline less and in some cases increase (for example, inflows to emerging Europe).

### Geopolitical drivers of FDI reallocation
- Bilateral FDI is increasingly concentrated among countries that share similar geopolitical views.
- Geopolitical alignment is measured by the “ideal point distance” based on UN General Assembly voting similarity.
- Comparative findings:
  - The share of FDI among geopolitically aligned partners is larger than the share going to geographically close partners, indicating geopolitical preferences play a key role.
  - The importance of geopolitical alignment for FDI has increased over the last decade.
  - Outward US FDI to China declined by much more than the average global decline, while US FDI to regions more politically aligned with the US (for example, Canada, Korea, emerging Europe) was more resilient.
- The chapter highlights that firms expressing interest in reshoring and friend-shoring tend to be on average larger, more profitable, and more knowledge-intensive (Figure 4.3 evidence using firm characteristics from Compustat, Hassan and others (2019), NL Analytics, and IMF staff calculations).

### Vulnerability to FDI relocation and cross-country distributional patterns
- The multidimensional vulnerability index indicates:
  - On average, emerging market and developing economies are more vulnerable to FDI relocation than advanced economies.
  - This greater vulnerability is largely because emerging market and developing economies rely more on FDI from countries with which they are relatively unaligned geopolitically.
  - Several large emerging markets across different regions show high vulnerabilities to relocation of FDI.
  - Better regulatory quality is associated with lower vulnerability; policies and regulations to promote private sector development could mitigate exposure to FDI relocation.

### Economic effects, spillovers, and firm-level findings
- The chapter empirically examines FDI spillovers using macro- and micro-level approaches.
- Key findings on FDI and growth:
  - Vertical FDI (more likely to be targeted by friend-shoring in strategic sectors) is associated with economic growth because of its knowledge-intensive nature.
  - The entry of multinational corporations benefits domestic firms:
    - In advanced economies, increased competition from foreign firms pushes domestic firms to become more productive.
    - In emerging market and developing economies, domestic suppliers benefit from technology transfers and increased local demand for inputs from foreign firms in downstream sectors.
- The literature on aggregate FDI effects is mixed; this chapter extends the literature by analyzing horizontal and vertical investment separately and by conducting firm-level analysis combining investment-level FDI data with cross-country firm-level surveys to identify productivity spillovers within and across sectors along value chains.

### Model-based scenarios and potential global costs
- Fragmentation is modeled in a multiregion dynamic stochastic general equilibrium (DSGE) framework as a permanent rise in investment barriers between opposing geopolitical blocs centered on the two largest economies (China and the US); nonaligned economies may face heightened uncertainty.
- Illustrative calibrated scenarios indicate:
  - FDI fragmentation—modeled as a permanent rise in cross-bloc barriers to importing investment inputs—could substantially reduce global output by about 2 percent in the long term.
  - Losses are likely to be unevenly distributed:
    - Emerging market and developing economies with reduced access to advanced economies would be particularly affected through both lower capital formation and reduced productivity gains.
    - Some economies could gain from diversion of investment inputs, but these benefits could be significantly offset by spillovers from lower external demand.
  - Nonaligned regions could have some negotiating power vis-à-vis geopolitical blocs, but uncertainty regarding their alignment could restrict their ability to attract investment.
- The estimated output losses underscore the importance of balancing strategic motivations behind reshoring and friend-shoring against economic costs to the countries themselves and to third parties, and of pursuing multilateral consultations to reduce uncertainty for bystanders.

### Policy implications and mitigation levers
- Efforts to preserve multilateral dialogue are needed to prevent increases in FDI fragmentation.
- Policy recommendations indicated by the analysis:
  - Strengthen multilateral engagement and consultations to reduce uncertainty and the likelihood of large-scale reallocation driven by geopolitical fragmentation.
  - Improve regulatory quality and promote private sector development to reduce vulnerability to FDI relocation, particularly in emerging market and developing economies.
  - Carefully weigh strategic objectives of reshoring and friend-shoring against their broader economic costs, including impacts on third-party countries via reduced external demand and lower productivity spillovers.

*Source: CHAPTER 4 GEOECONOMIC FRAGMENTATION AND FOREIGN DIRECT INvEsTMENT, text - CHAPTER 4 GEOECONOMIC FRAGMENTATION AND FOREIGN DIRECT INvEsTMENT (PDF).*

### CHAPTER 4 GEOECONOMIC FRAGMENTATION AND FOREIGN DIRECT INvEsTMENT

### CHAPTER 4 GEOECONOMIC FRAGMENTATION AND FOREIGN DIRECT INvEsTMENT

### Geopolitical distance and FDI: gravity-model findings
- A gravity model with bilateral FDI (measured by the number of investments) as the dependent variable finds geopolitical alignment matters economically for FDI flows.
- An increase in the ideal point distance from the first to the third quartile of its distribution (equivalent to moving the distance from that between Canada and Japan to that between Canada and Jordan) is associated with a decline in FDI between countries of about 17 percent.
- The average effect is much stronger when emerging market and developing economies (EMDEs) are either a source or a host country.
- Since 2018, geopolitical factors have become more relevant to FDI flows, coincident with increasing trade tensions between China and the US.
- Geopolitical distance matters more for investments in strategic sectors than for nonstrategic ones (see Figure 4.8 semielasticities).
- Robustness: the coefficient on ideal point distance remains statistically and economically significant after augmenting the model with geographic, cultural, institutional distance, historical colonial ties, separating manufacturing and services, excluding financial centers or China, controlling for announcement and implementation of bilateral trade barriers, for bilateral trade volumes, for exchange rate effects, measuring FDI by size rather than number of investments, and considering cross-border M&As rather than greenfield FDI.
- Estimation details (model specification highlights):
  - Specification: bilateral FDI flows FDI_sdt = f(α IPD_sdt−1 + β Gravity_sd + τ_st + υ_dt, ε_sdt).
  - Controls include lagged ideal point distance (IPD), geographic distance, other standard gravity controls, and source country × year and host country × year fixed effects.
  - Because most FDI_sdt cells are 0, estimation uses Poisson pseudo-maximum likelihood (Santos Silva and Tenreyro 2006).
  - Standard errors clustered at the country-pair level.

### Vulnerability to FDI relocation: index construction and patterns
- The chapter develops a multidimensional vulnerability index combining three subindices relevant to geoeconomic fragmentation:
  1. Geopolitical index
     - Constructed by multiplying the share of investment from each source country by the geopolitical distance between host and source countries.
     - Given that most countries receive much of their FDI from advanced economies, and those economies are geopolitically closer to one another than to EMDEs, EMDEs are more geopolitically vulnerable than advanced economies (AEs).
  2. Market power index
     - Treats FDI in a sector as less vulnerable if the host country is among the top 10 exporters in that sector; otherwise FDI is treated as fully vulnerable.
     - Most economies show low levels of protection from market power; some large economies (China, Germany, US) enjoy protection in many sectors.
  3. Strategic index
     - Measures the share of inward FDI in strategic sectors.
     - Shows substantial overlap between advanced and emerging market and developing economies.
- Aggregate index construction:
  - The aggregate index adds the strategic and geopolitical dimensions, with the geopolitical component multiplied by the market power index (bounded between 0 and 1) to allow dampening of geopolitical vulnerability where host countries have market power.
  - Market power offsets geopolitical distance only for sectors in which the host economy is among the top 10 exporters.
  - The strategic dimension is added because investments in strategic sectors are more likely to be targeted with reshoring policies, offsetting protection from market power.
- Distributional findings:
  - Overall, EMDEs are more vulnerable to FDI fragmentation than AEs, but there is large variation and overlap: 14 percent of EMDEs have a vulnerability index lower than the median for AEs.
  - Regional patterns: Europe is in a better position; other regions show higher and similar levels of vulnerability (Figure 4.9, panel 4).
  - The geopolitical and strategic dimensions are broadly uncorrelated; median values indicated in Figure 4.10 are strategic index = 0.09 and geopolitical index = 0.5.
  - A cluster of countries vulnerable on both dimensions includes Brazil, China, India, and several other EMDEs.

### Policy-relevant correlations and mitigation
- Regulatory quality and vulnerability:
  - Stronger regulatory quality tends to be associated with lower aggregate vulnerability to FDI relocation.
  - The binned scatterplot regression (cross section of 128 countries, variables averaged over 2010–19) of the aggregate vulnerability index against the regulatory quality index, controlling for log real GDP, trade (percent of GDP), and FDI inflows (percent of GDP), gives a coefficient of the regulatory quality index equal to –0.057 (p-value of 0.000).
  - Improved regulatory quality is also associated with higher exports, which could offer protection against relocation pressures.
- Policy takeaway:
  - Beyond multilateral efforts to preserve cooperation, domestic policies—such as improving regulatory quality—could help reduce future vulnerabilities to geoeconomic fragmentation.

### FDI spillovers: heterogeneity and channels
- FDI can generate spillovers to domestic firms through technology diffusion, backward and forward linkages, and productivity gains from increased competition.
- Empirical findings are mixed; spillover effects depend on host countries’ human capital, institutional quality, and financial development.
- Horizontal versus vertical FDI:
  - Horizontal FDI: foreign firms enter to serve local markets directly; more likely among final-goods producers transferring simple, labor-intensive assembly technology.
  - Vertical FDI: foreign firms enter to produce inputs supplied to affiliated firms; concentrated among intermediate-goods producers that adopt more sophisticated, skill-intensive technology.
  - Vertical FDI is more exposed to FDI fragmentation risk than horizontal FDI because higher trade barriers make vertical FDI less attractive, and vertical FDI often involves advanced technology targeted by reshoring policies.
  - Vertical FDI is positively associated with economic growth, while horizontal FDI is not, based on cross-country growth regressions estimated separately for countries more likely to receive vertical or horizontal FDI.
- Spillovers within and across industries:
  - Entry of a multinational affects domestic firms differently depending on whether those firms are in the same sector (within-industry) or upstream/downstream sectors (across-industry).
  - Within-industry effects can raise incentives to innovate and increase productivity or crowd out local firms by stealing market share.
  - The interpretation of empirical results should take into account potential endogeneity of FDI; the analysis addresses this in part by using lagged values of FDI and including fixed effects, and firm-level analysis is used to further explore heterogeneity.

*Source: CHAPTER 4 GEOECONOMIC FRAGMENTATION AND FOREIGN DIRECT INvEsTMENT, text - CHAPTER 4 GEOECONOMIC FRAGMENTATION AND FOREIGN DIRECT INvEsTMENT*

### CHAPTER 4 GEOECONOMIC FRAGMENTATION AND FOREIGN DIRECT INvEsTMENT

### CHAPTER 4 GEOECONOMIC FRAGMENTATION AND FOREIGN DIRECT INvEsTMENT

### Firm-level evidence on FDI spillovers
- Results from World Bank Enterprise Surveys covering over 120,000 firms in 150 countries from 2006 to 2021 show positive spillovers to domestic firms in the same industry (Figure 4.13, top graph).
- Positive within-industry spillovers to firms’ labor productivity are confined to advanced economies, where firms react to fiercer competition from multinational corporations by becoming more productive.
- Cross-industry spillovers:
  - Domestic suppliers benefit from the entry of foreign firms in downstream sectors through local sourcing and increased local demand for inputs.
  - Local suppliers may benefit from learning by doing via direct contact with foreign buyers with better technology.
  - These positive spillovers to domestic suppliers are driven by FDI in emerging market and developing economies.
- There is no evidence of spillovers to domestic users, even in emerging market and developing economies, possibly because foreign firms in upstream sectors mostly sell abroad, implying limited scope for positive technology spillovers via direct contact with local buyers.

### Model-based quantification: design and assumptions
- Purpose: Investigate long-term implications of potential FDI fragmentation using a multiregion DSGE model (IMF’s Global Integrated Monetary and Fiscal Model).
- Proxy for FDI: Bilateral cross-border flow of inputs into investment is used as a proxy for foreign ownership of productive capital because the model lacks explicit foreign ownership of productive capital.
- Key parameter and shock:
  - Scenarios illustrate a 50 percent reduction of such investment-input flows between blocs.
  - Empirical estimates of the correlation between FDI flows and labor productivity are used to discipline associated productivity losses.
- Regions modeled (up to eight):
  - China, the EU+ (EU and Switzerland), the US, Latin America and the Caribbean (LAC), India and Indonesia, southeast Asia, other advanced economies, and the rest of the world (ROW).
- Baseline alignment assignment: Regions assigned to geopolitical blocs using ideal point distance; additional scenarios vary alignment of EU+, India and Indonesia, and LAC.
- Elasticity of substitution cases between foreign sources of investment inputs:
  - Baseline (lower elasticity): 1.5
  - Alternative (higher elasticity, double in value): 3.0
- Policy uncertainty case for nonaligned economies:
  - Investors perceive a 50 percent chance that the nonaligned region will fall in with the opposing bloc over the long term.
  - Under this case, investors behave as if investment input flows to (from) these regions face half the barriers faced by regions in the opposing bloc.

### Scenario outcomes and numerical impacts
- Decoupling between China and the US (with India and Indonesia and LAC remaining nonaligned) results:
  - Global output is about 1 percent lower after five years (relative to the no-fragmentation scenario).
  - Long-term output lower by 2 percent.
- Distribution of impacts:
  - Output losses are generally larger in the emerging-market-dominated China bloc, which faces heightened barriers to major sources of investments (advanced economies).
  - The US bloc also experiences nonnegligible losses due to close links of some members to China (for example, Japan and Korea in other advanced economies and Germany in EU+).
- Nonaligned regions:
  - Two competing channels determine impact:
    - Reduced external demand from lower global activity (negative for net exports and investment).
    - Diversion of investment flows toward nonaligned regions (could boost investment and output if substitution is easy).
  - Benchmark elasticity (1.5): The first channel dominates and nonaligned regions experience a small drop in output.
  - Higher elasticity (3.0): Diversion yields a small net increase in investment and output for nonaligned regions.
- Policy uncertainty amplification:
  - High uncertainty for nonaligned regions (50 percent perceived chance of future alignment) significantly amplifies losses for nonaligned economies as they face reduced inflows from both blocs, with some negative spillovers to other regions as well.
- Modeled fragmentation scenarios and regional GDP shares (Model Region GDP Share (Percent)):
  - United States 16.0
  - China 17.5
  - EU+ 15.6
  - Other AEs 13.8
  - India and Indonesia 9.6
  - Southeast Asia 4.0
  - LAC 6.5
  - ROW 17.0

### Mechanisms highlighted
- Barriers to investment reduce capital formation in host economies and transmission of technologies and productivity-enhancing management practices from advanced to emerging market and developing economies.
- Reductions in bilateral investment-input flows operate through:
  - Direct declines in capital stock accumulation.
  - Productivity losses linked empirically to reductions in FDI flows.
- Diversion effects depend critically on the elasticity of substitution of investment inputs across source regions.
- Policy uncertainty acts as an additional barrier, reducing investment even when nonaligned status could theoretically attract diversion.

### Policy implications and recommendations
- A fragmented global economy is likely to be poorer, with potential absolute and relative winners from diversion but such gains are subject to substantial uncertainty.
- The pursuit of strategic objectives via decoupling entails large economic costs for the country imposing barriers, rivals, and nonaligned countries; these costs should be carefully weighed against security or technological goals.
- Rationale for defending global integration:
  - Increasing diversification in international sourcing of inputs can make supply chains more resilient without imposing costs on the world economy.
  - The rules-based multilateral system must adapt and be complemented by credible “guardrails” to mitigate global spillovers.
  - Domestic policies should target those adversely affected by global integration.
- Minimize policy uncertainty:
  - Improve information sharing through multilateral dialogue.
  - Develop a framework for international consultations (for example, on the use of subsidies to incentivize reshoring or friend-shoring of FDI) to identify unintended consequences and increase transparency on policy options.
- Reduce vulnerability to FDI relocation:
  - Implement policies and regulations to promote private sector development to make economies less susceptible to capital reallocation driven by geopolitical fragmentation.
- Consider transfer mechanisms:
  - Blocs attracting nonaligned regions could offer transfers—such as favorable trade and investment treatment or fiscal measures—to secure alignment, although such moves could generate damaging uncertainty if they provoke countermeasures.

*Source: CHAPTER 4 GEOECONOMIC FRAGMENTATION AND FOREIGN DIRECT INvEsTMENT, text - CHAPTER 4 GEOECONOMIC FRAGMENTATION AND FOREIGN DIRECT INvEsTMENT, World Economic Outlook, April 2023.*

### 1. Impact of Nonaligned EU+, with and without Uncertainty

### 1. Impact of Nonaligned EU+, with and without Uncertainty

### Impact on GDP for Bloc Members: Nonaligned Joining Blocs
- Figure summary: Percent deviation from nonaligned scenario with uncertainty for bloc members when nonaligned regions join blocs.
- Findings:
  - Remaining nonaligned with certainty tends to limit losses.
  - Blocs have incentives to attract nonaligned regions and discourage nonaligned from joining the opposing bloc.
- Specific labeled groups in figures:
  - EU+ = European Union and Switzerland.
  - The nonaligned include India and Indonesia and Latin America and the Caribbean.
  - Bloc labels shown: China bloc, US bloc, China bloc with new members, US bloc with new members.
- Visual axis markers in the figures (as presented):
  - First figure axis: –4, –3, –2, –1, 0, 1 (with "EU+China bloc" label near positive end).
  - Second figure axis: –2.5, –2.0, –1.5, –1.0, –0.5, 0.0, 0.5 (with categories: Both nonaligned, Both join China bloc, Both join US bloc).
  - Third figure axis: –0.2, –0.1, 0.0, 0.1, 0.2, 0.3, 0.4 (with labels: Nonaligned joining China bloc, Nonaligned joining US bloc).

### Policy-relevant implications on foreign direct investment (FDI)
- Fragmented world with friend-shoring policies could create opportunities for some countries by diverting FDI.
- Measures that increase attractiveness as investment destinations:
  - Undertake structural reforms (Campos and Kinoshita 2010).
  - Establish investment promotion agencies to reduce information asymmetries and ease bureaucratic procedures (Harding and Javorcik 2011; Crescenzi, Di Cataldo, and Giua 2021).
  - Improve infrastructure (Chen and Lin 2020).

### Box 4.1 — Rising Trade Tensions (timeline and drivers)
- Context and drivers:
  - China’s accession to the World Trade Organization (WTO) in 2001 coincided with world trade volumes almost doubling since then and China becoming the world’s top exporter and second-largest economy.
  - Trade tensions grew as China’s rapid export growth affected segments of European and US industry and concerns about the economic role of the state, technology transfer practices, and state-owned enterprises increased.
  - The inability of WTO members to agree on reforms in sensitive areas has exacerbated trade tensions.
- Timeline highlights (selected events and exact figures as presented):
  - US imposes 25% tariff on $34 billion in Chinese imports.
  - 25% tariff retaliation on $34 billion in US imports.
  - 25% tariff retaliation on $60 billion in US imports.
  - US-China trade war resumes, with Huawei added to entity list and additional 25% tariff on $200 billion in Chinese imports.
  - Phase One trade agreement (early 2020).
  - Extended ban on investments in Chinese companies with ties to the Chinese military.
  - New export controls prohibiting sales of advanced chips and chip-making technology to China.
  - President Biden signs Creating Helpful Incentives to Produce Semiconductors and Science Act, and Inflation Reduction Act (CHIPS and Science Act; IRA).
  - Indo-Pacific Economic Framework for Prosperity launched with a dozen partners.
  - EU’s proposed European Chips Act aims to boost the bloc’s semiconductor industry to 20 percent of global production capacity by 2030, with more than €43 billion in investments.
- Consequences:
  - Tensions widened to a technological front, with the US aiming to hinder China’s advancement in sectors such as semiconductors and green energy equipment.
  - Ongoing US blockage of WTO Appellate Body appointments has left many disputes unresolved.

### Box 4.2 — Balance Sheet Exposure to Fragmentation Risk
- Measurement approach:
  - Exposure defined as the stock of non–FDI foreign assets (liabilities) invested in (borrowed from) countries with diverging geopolitical views.
  - Cross-border non-FDI financial linkages constructed from IMF Coordinated Portfolio Investment Survey (CPIS) and Bank for International Settlements Locational Banking Statistics.
  - Bilateral portfolio holdings reallocated to proper source and host countries following Coppola and others (2021).
  - Political proximity captured by the ideal point distance normalized to 1 for the politically closest country and 0 for the most distant.
  - Exposure = difference between undiscounted positions and politically weighted counterparts.
- Key quantitative findings:
  - Exposures are large and have roughly doubled over the past 20 years.
  - Gross foreign investment positions (assets plus liabilities) as a share of GDP have more than doubled since 2001, while politically weighted positions have not grown as fast.
  - In aggregate, exposures have now reached 42 percent of GDP, or 24 percent of all non-FDI cross-border holdings.
- Distributional patterns:
  - Exposures are concentrated on the asset side in advanced economies and on the liability side in emerging markets.
  - Exposures vary significantly across the Group of Twenty (G20).

### Box 4.3 — Geopolitical Tensions, Supply Chains, and Trade
- Estimation and calibration:
  - Estimated impact of geopolitical alignment on sector-level bilateral trade data for 189 countries across 10 broad manufacturing sectors using structural gravity regressions.
  - Divergences in geopolitical alignment act as a barrier to trade, concentrated in some sectors (notably food, transportation equipment, and other manufacturing).
  - Calibrated a multicountry, multisector general equilibrium trade model for a fragmentation scenario: increase in alignment within US, China, and nonaligned blocs, reduced alignment across blocs, and a doubling of the estimated sensitivity of trade barriers to geopolitical alignment.
  - Countries assigned to blocs based on whether their current geopolitical treaties are stronger with the US, stronger with China, or equally strong with both.
- Three main factors driving exposure to geoeconomic fragmentation:
  1. Economy size: smaller economies (population and GDP) are more damaged by a given rise in trade barriers because they rely more on international trade.
  2. Comparative advantage: greater effect on countries that import in sectors with trade barriers more sensitive to geopolitical alignment.
  3. Geoeconomic alignment: fragmentation is more damaging to countries that are not closely aligned with either of the world’s two major economies.
- Quantitative and distributional results:
  - Trade barriers increase more in sectors such as food, transportation equipment, and other manufacturing (sector-level log-change impacts illustrated in Figure 4.3.1).
  - While geoeconomic fragmentation leads to income losses for most countries, it hurts emerging market and developing economies more than advanced economies.
  - For the median emerging market economy in Africa and central Asia, real income losses due to geoeconomic fragmentation are more than twice as large as for the median advanced economy (Figure 4.3.2 distributions shown by region: AEs; EM Asia; EM Europe; LAC; ME&CA; SSA).

*Source: IMF staff calculations and boxes from the chapter "Geoeconomic Fragmentation and Foreign Direct Investment," WORLD ECONOMIC OUTLOOK: A ROCKy RECOvERy, International Monetary Fund | April 2023.*

### CHAPTER 4 GEOECONOMIC FRAGMENTATION AND FOREIGN DIRECT INvEsTMENT

### CHAPTER 4 GEOECONOMIC FRAGMENTATION AND FOREIGN DIRECT INvEsTMENT

### Key assumptions for 2023–24 projections
- Data in the statistical tables are compiled on the basis of information available through March 28, 2023.
- Real effective exchange rates for the advanced economies are assumed to remain constant at their average levels measured during February 15, 2023–March 15, 2023.
- Assumed average conversion rates:
  - US dollar–special drawing right conversion rates of 1.334 and 1.333 for 2023 and 2024, respectively.
  - US dollar–euro conversion rates of 1.063 and 1.054 for 2023 and 2024, respectively.
  - Yen–US dollar conversion rates of 135.4 and 137.4 for 2023 and 2024, respectively.
- Oil price assumptions:
  - Price of oil will average $73.13 a barrel in 2023.
  - Price of oil will average $68.90 a barrel in 2024.
- Short-term government bond yield assumptions (three-month):
  - United States: 5.1 percent in 2023 and 4.5 percent in 2024.
  - Euro area: 2.8 percent in 2023 and 3.0 percent in 2024.
  - Japan: −0.1 percent in 2023 and 0.0 percent in 2024.
- Long-term government bond yield assumptions (10-year):
  - United States: 3.8 percent in 2023 and 3.6 percent in 2024.
  - Euro area: 2.5 percent in 2023 and 2.8 percent in 2024.
  - Japan: 0.6 percent in 2023 and 0.6 percent in 2024.
- National authorities’ established policies are assumed to be maintained.
- The figures for 2023–24 are shown with the same degree of precision as historical figures solely for convenience; because they are projections, the same degree of accuracy is not to be inferred.

### What’s new (database and country-group changes)
- Beginning with the April 2023 WEO, ASEAN-5 comprises the five ASEAN founding member nations: Indonesia, Malaysia, the Philippines, Singapore, and Thailand.
- On January 1, 2023, Croatia became the 20th country to join the euro area; data for Croatia are now included in aggregates for the euro area and for advanced economies and relevant subgroups.
- For Ecuador, fiscal sector projections are excluded from publication for 2023–28 because of ongoing program discussions.

### Data coverage, standards, and aggregation conventions
- The WEO database comprises data and projections for 196 economies.
- Data are maintained jointly by the IMF’s Research Department and regional departments; regional departments regularly update country projections based on consistent global assumptions.
- Most countries’ macroeconomic data as presented in the WEO conform broadly to the 2008 version of the System of National Accounts (SNA 2008).
- IMF sector statistical standards aligned with SNA 2008 include:
  - Balance of Payments and International Investment Position Manual (BPM6).
  - Monetary and Financial Statistics Manual and Compilation Guide.
  - Government Finance Statistics Manual 2014 (GFSM 2014).
- Fiscal gross and net debt data reported in the WEO are drawn from official data sources and IMF staff estimates; efforts are made to align these data with GFSM 2014 definitions, but deviations can occur due to data limitations or specific country circumstances.
- Conversion and weighting conventions:
  - Country group composites for exchange rates, interest rates, and growth rates of monetary aggregates are weighted by GDP converted to US dollars at market exchange rates (averaged over the preceding three years) as a share of group GDP.
  - Composites for other domestic economy data (growth rates or ratios) are weighted by GDP valued at purchasing power parity as a share of total world or group GDP.
  - For aggregation of world and advanced economies (and subgroups) inflation, annual rates are simple percentage changes from the previous years; for aggregation of emerging market and developing economies (and subgroups) inflation, annual rates are based on logarithmic differences.
  - Composites for real GDP per capita in PPP terms are sums of individual country data after conversion to international dollars.
  - Composites for fiscal data are sums of individual country data after conversion to US dollars at the average market exchange rates in the years indicated.
  - Composite unemployment rates and employment growth are weighted by labor force as a share of group labor force.
  - Composites relating to external sector statistics are sums of individual country data after conversion to US dollars at the average market exchange rates in the years indicated for balance of payments data and at end-of-year market exchange rates for debt denominated in currencies other than US dollars.
  - Composites of changes in foreign trade volumes and prices are arithmetic averages of percent changes for individual countries weighted by the US dollar value of exports or imports as a share of total world or group exports or imports (in the preceding year).
- Unless noted otherwise, group composites are computed if 90 percent or more of the share of group weights is represented.
- Unless noted otherwise, composites for all sectors for the euro area are corrected for reporting discrepancies in intra-area transactions.
- Unadjusted annual GDP data are used for the euro area and for the majority of individual countries, except Cyprus, Ireland, Portugal, and Spain, which report calendar-adjusted data.
- For data prior to 1999, data aggregations apply 1995 European currency unit exchange rates.

### Statistical appendices and supporting material
- The Statistical Appendix comprises eight sections: Assumptions; What’s New; Data and Conventions; Country Notes; Classification of Countries; General Features and Composition of Groups in the World Economic Outlook Classification; Key Data Documentation; and Statistical Tables.
- Statistical Appendix A is included in the printed report; Statistical Appendix B is available online.
- The process of adapting country data to new statistical manuals (SNA 2008, BPM6, GFSM 2014) depends on national statistical compilers providing revised country data; many countries have partially adopted the latest standards and will continue implementation over a number of years.

*Source: CHAPTER 4 GEOECONOMIC FRAGMENTATION AND FOREIGN DIRECT INvEsTMENT, World Economic Outlook, International Monetary Fund, April 2023.*

### Appendix 1.1 of the April 2008 WEO, Box A2 of the April 2004

### Appendix 1.1 of the April 2008 WEO, Box A2 of the April 2004

### Data scope and reporting conventions
- Data refer to calendar years, except in the case of a few countries that use fiscal years; Table F lists the economies with exceptional reporting periods for national accounts and government finance data.
- For some countries, the figures for 2022 and earlier are based on estimates rather than actual outturns; Table G lists the latest actual outturns for the indicators in the national accounts, prices, government finance, and balance of payments for each country.
- See also Anne-Marie Gulde and Marianne Schulze-Ghattas, “Purchasing Power Parity Based Weights for the World Economic Outlook,” in Staff Studies for the World Economic Outlook (Washington, DC: International Monetary Fund, December 1993), 106–23.

### Country-specific notes and exceptions
- Afghanistan
  - Data and projections for 2021–28 are omitted because of an unusually high degree of uncertainty given that the IMF has paused its engagement with the country owing to a lack of clarity within the international community regarding the recognition of a government in Afghanistan.
- Algeria
  - Total government expenditure and net lending/borrowing include net lending by the government, which mostly reflects support to the pension system and other public sector entities.
- Argentina
  - The official national consumer price index (CPI) starts in December 2016.
  - For earlier periods, CPI data reflect: the Greater Buenos Aires Area CPI (prior to December 2013), the national CPI (IPCNu, December 2013 to October 2015), the City of Buenos Aires CPI (November 2015 to April 2016), and the Greater Buenos Aires Area CPI (May 2016 to December 2016).
  - Given limited comparability of these series on account of differences in geographical coverage, weights, sampling, and methodology, the WEO does not report average CPI inflation for 2014–16 and end-of-period inflation for 2015–16.
  - Argentina discontinued the publication of labor market data starting in the fourth quarter of 2015, and new series became available starting in the second quarter of 2016.
- Bangladesh
  - Data and forecasts are presented on a fiscal year basis.
  - Country group aggregates that include Bangladesh use calendar year estimates of real GDP and purchasing-power-parity GDP.
- Costa Rica
  - The central government definition has been expanded as of January 1, 2021, to include 51 public entities as per Law 9524.
  - Data back to 2019 are adjusted for comparability.
- Dominican Republic
  - The fiscal series have the following coverage: Public debt, debt service, and the cyclically adjusted/structural balances are for the consolidated public sector (which includes the central government, the rest of the nonfinancial public sector, and the central bank); the remaining fiscal series are for the central government.
- Ecuador
  - The authorities are undertaking revisions of the historical fiscal data with technical support from the IMF.
  - Fiscal sector projections are excluded from publication for 2023–28 because of ongoing program discussions.
- India
  - Real GDP growth rates are calculated as per national accounts: for 1998–2011 with base year 2004/05 and, thereafter, with base year 2011/12.
- Lebanon
  - Data and projections for 2021–28 are omitted owing to an unusually high degree of uncertainty.
- Sierra Leone
  - Redenominated its currency on July 1, 2022; however, local currency data are expressed in the old leone for the April 2023 WEO.
- Sri Lanka
  - Certain projections for 2023–28 are excluded from publication owing to ongoing discussions on sovereign debt restructuring.
- Syria
  - Data are excluded from 2011 onward because of the uncertain political situation.
- Turkmenistan
  - Real GDP data are IMF staff estimates compiled in line with international methodologies (SNA), using official estimates and sources as well as United Nations and World Bank databases.
  - Estimates of and projections for the fiscal balance exclude receipts from domestic bond issuances as well as privatization operations, in line with the GFSM 2014.
  - The authorities’ official estimates for fiscal accounts, which are compiled using domestic statistical methodologies, include bond issuance and privatization proceeds as part of government revenues.
- Ukraine
  - All projections for 2024–28 are omitted owing to an unusually high degree of uncertainty.
  - Revised national accounts data are available beginning in 2000 and exclude Crimea and Sevastopol from 2010 onward.
- Uruguay
  - In December 2020 the Uruguay authorities began reporting the national accounts data according to the SNA 2008, with the base year 2016. The new series begin in 2016. Data prior to 2016 reflect the IMF staff’s best effort to preserve previously reported data and avoid structural breaks.
  - Since October 2018 Uruguay’s public pension system has been receiving transfers in the context of a new law that compensates persons affected by the creation of the mixed pension system. These funds are recorded as revenues, consistent with the IMF’s methodology. Therefore, data and projections for 2018–22 are affected by these transfers, which amounted to 1.2 percent of GDP in 2018.

*Source: Appendix 1.1 of the April 2008 WEO, Box A2 of the April 2004 WEO, Box A1 of the May 2000 WEO, and Annex IV of the May 1993 WEO as reproduced in the provided document.*

### 1.1 percent of GDP in 2019, 0.6 percent of GDP

### text - 1.1 percent of GDP in 2019, 0.6 percent of GDP

### Fiscal data coverage and revisions (Uruguay)
- Coverage of fiscal data for Uruguay changed from consolidated public sector to nonfinancial public sector with the October 2019 WEO.
- Nonfinancial public sector coverage in Uruguay includes the central government, local government, social security funds, nonfinancial public corporations, and Banco de Seguros del Estado.
- Under the narrower fiscal perimeter (which excludes the central bank):
  - Assets and liabilities held by the nonfinancial public sector for which the counterpart is the central bank are not netted out in debt figures.
  - Capitalization bonds issued in the past by the government to the central bank are now part of the nonfinancial public sector debt.
- Historical data were revised accordingly; gross and net debt estimates for 2008–11 are preliminary.
- A staff reference: IMF Country Report 19/64 (Uruguay Staff Report for the 2018 Article IV Consultation) is cited for further details.

### Data limitations and projection caveats (Venezuela)
- Projecting the economic outlook for Venezuela is difficult due to:
  - Lack of discussions with the authorities (most recent Article IV consultation: 2004).
  - Incomplete metadata and limited reported statistics.
  - Difficulties reconciling reported indicators with economic developments.
- Fiscal accounts for Venezuela include:
  - Budgetary central government; social security; FOGADE (insurance deposit institution); and a reduced set of public enterprises, including Petróleos de Venezuela, S.A. (PDVSA).
- Methodological upgrades were applied to achieve a more robust nominal GDP; historical data and indicators expressed as a percentage of GDP have been revised from 2012 onward.
- For most indicators, data for 2018–22 are IMF staff estimates.
- Effects of hyperinflation and paucity of reported data mean IMF staff’s projected macroeconomic indicators should be interpreted with caution; broad uncertainty surrounds these projections.
- Venezuela’s consumer prices are excluded from all WEO group composites.

### Currency redenomination and data re-basing (Zimbabwe)
- In 2019 Zimbabwe authorities introduced the Real Time Gross Settlement dollar, later renamed the Zimbabwe dollar.
- Authorities are in the process of redenominating their national accounts statistics.
- Current data are subject to revision.
- Historical context: the Zimbabwe dollar previously ceased circulating in 2009; during 2009–19 Zimbabwe operated under a multicurrency regime with the US dollar as the unit of account.

### Specific numeric fiscal series noted
- Series value examples from the source text:
  - "1.1 percent of GDP in 2019, 0.6 percent of GDP in 2020, and 0.3 percent of GDP in 2021 and are projected to be 0.1 percent of GDP in 2022 and 0   percent thereafter."
  - The disclaimer about the public pension system applies only to the revenues and net lending/borrowing series.
- These numeric series are retained verbatim and indicate declining values across 2019–2022 and zeros thereafter as presented.

### WEO country classification: structure and key aggregates
- The WEO divides countries into two major groups: advanced economies and emerging market and developing economies (EMDEs).
- Advanced economies: 41 listed (Table B). The seven largest by GDP at market exchange rates form the Group of Seven (United States, Japan, Germany, France, Italy, the United Kingdom, Canada).
- Emerging Market and Developing Economies: 155 (all countries not classified as advanced).
- Regional breakdowns for EMDEs include:
  - Emerging and developing Asia; emerging and developing Europe; Latin America and the Caribbean; Middle East and Central Asia; and sub-Saharan Africa.
- Analytical groupings include:
  - By source of export earnings: fuel vs nonfuel, with further focus on nonfuel primary products (SITCs 0, 1, 2, 4, and 68). Economies placed in a group if main export earnings source exceeded 50 percent of total exports on average between 2017 and 2021.
  - By external financing source: net creditor vs net debtor economies; differentiation based on latest net international investment position or accumulated current account balance from 1972 (or earliest available) to 2021.
  - Heavily Indebted Poor Countries (HIPCs) and Low-Income Developing Countries (LIDCs) are defined by participation status and income thresholds.
- Note: Some countries are excluded from classification and analysis (examples given: Cuba and the Democratic People’s Republic of Korea are not IMF members and thus not monitored).

### Selected headline country and group aggregates (verbatim numeric facts from tables)
- Table A (shares in aggregate GDP, exports, population, 2022):
  - Advanced Economies: Number of economies 41; GDP share 100.0 (for group) and World 41.7 percent.
  - Emerging Market and Developing Economies: Number of economies 155; GDP share 100.0 (for group) and World 58.3 percent.
  - United States: GDP share 37.3 (Advanced Economies column), World 15.6.
  - China: GDP share 31.7 (Emerging and Developing Asia column), World 18.5.
- Table A1. Summary of World Output (annual percent change):
  - World average 2005–14: 3.9; 2022: 3.4; projections: 2023 = 2.8; 2024 = 3.0.
  - Advanced Economies: 2005–14 average 1.5; 2022 = 2.7; projections 2023 = 1.3; 2024 = 1.4.
  - Emerging Market and Developing Economies: 2005–14 average 6.1; 2022 = 4.0; projections 2023 = 3.9; 2024 = 4.2.
- Table A5. Summary of Inflation (percent):
  - Advanced Economies GDP deflators: 2022 = 5.4; projections 2023 = 3.9; 2024 = 2.5.
  - Emerging Market and Developing Economies consumer prices: 2022 = 9.8; projections 2023 = 8.6; 2024 = 6.5.
- Table A8. Major Advanced Economies: General Government Fiscal Balances and Debt (percent of GDP):
  - Major Advanced Economies Net Lending/Borrowing: average 2005–14 = –5.2; 2022 = –11.6; projections 2023 = –9.1; 2024 = –5.4.
  - United States Net Debt (percent of GDP): listed as 63.9 (2005–14 avg) and values up to 110.5 in projections table context.
- Table A9. World trade:
  - World trade volume: 2021 = 10.6 percent; 2022 = 5.1 percent; projections 2023 = 2.4 percent; 2024 = 3.5 percent.
  - Average oil price (in US dollars a barrel): historical series includes values such as 83.6, 62.6, 55.0, etc., as reported in the table.
- Table A10. Summary of Current Account Balances (billions of US dollars):
  - World (memorial): figures include 2015 = 180.2; 2021 = 760.9; 2022 = 324.2; projections 2023 = 160.1; 2024 = 198.9.
- Table A15. Summary of World Medium-Term Baseline Scenario:
  - World Real GDP projections: 2023 = 2.8 percent; 2024 = 3.0 percent; 2025–28 average = 3.9 percent.
  - Advanced Economies real GDP: 2023 = 1.3 percent; 2024 = 1.4 percent; 2025–28 average = 1.8 percent.
  - Emerging Market and Developing Economies real GDP: 2023 = 3.9 percent; 2024 = 4.2 percent; 2025–28 average = 3.9 percent.

### Fiscal and monetary policy assumptions (summary of approach)
- Short-term fiscal policy assumptions:
  - Based on officially announced budgets, adjusted for differences between national authorities and IMF staff macroeconomic assumptions and projected fiscal outturns.
  - When no official budget exists, projections incorporate measures judged likely to be implemented.
  - When insufficient information, an unchanged structural primary balance is assumed unless indicated otherwise.
- Country-specific fiscal assumptions:
  - Examples: Argentina projections based on federal government data and IMF-supported program targets; Australia projections based on FY2022/23 budget and state/territory forecasts; many other countries’ projections are tied to their 2023 budgets or latest fiscal plans (sampled in Box A1).
- Monetary policy assumptions:
  - Based on established policy frameworks in each country; typically a nonaccommodative stance over the business cycle.
  - Country-specific assumptions align with central bank targets or market expectations (examples: Brazil — inflation convergence by end-2024; Canada — keep rates high to bring inflation back to target by end of 2024; China — broadly accommodative in 2023; Euro area — drawn from suite of models and ECB communication).

*International Monetary Fund | April 2023 — World Economic Outlook: A Rocky Recovery (Statistical Appendix).*

### Annex 1.SF.1

### Annex 1.SF.1

### Executive Board discussion of the outlook (March 2023)
- Executive Directors broadly agreed with staff’s assessment of the global economic outlook, risks, and policy priorities.
- They considered that the persistence of high inflation in many countries and recent financial sector stresses increase the challenges to global economic prospects and leave policymakers with a narrow path to restore price stability, while avoiding a recession and maintaining broad financial stability.
- Directors generally concurred that many of the forces that shaped the world economy in 2022—including Russia’s war in Ukraine and geopolitical tensions, high debt levels constraining fiscal responses, and tighter global financial conditions—appear likely to continue into this year.
- Directors expressed concern that the medium-term growth projections for the global economy remain the lowest in decades.

### Downside risks and scenarios highlighted
- Risks to the outlook have increased and are tilted to the downside.
- Specific risk factors noted:
  - Core inflation could turn out more persistent than anticipated, calling for even tighter monetary policies.
  - Recent stresses in the banking sector could amplify with contagion effects.
  - Pockets of sovereign debt distress could become more widespread due to wider exchange rate movements and higher borrowing costs.
  - The war in Ukraine and geopolitical conflicts could intensify and lead to more food and energy price spikes as well as further geoeconomic fragmentation.
- Most Directors agreed that fragmentation into geopolitical blocs could generate large output losses, including through effects on foreign direct investment, and especially affecting emerging market and developing economies.

### Multilateral cooperation and debt restructuring
- Directors reiterated a strong call for multilateral cooperation to:
  - Defuse geopolitical tensions.
  - Safeguard the functioning of global financial markets.
  - Manage debt distress.
  - Foster global trade and reinforce the multilateral trading system.
  - Ensure food and energy security.
  - Advance the green and digital transitions.
  - Improve resilience to future pandemics.
- Directors stressed the need for multilateral institutions to stand ready to provide timely support to safeguard essential spending and ensure any crises remain contained.
- Importance of improving debt transparency and better mechanisms to produce orderly debt restructurings was emphasized, including a more effective Common Framework when insolvency issues prevail.
- Directors encouraged the newly established Global Sovereign Debt Roundtable to become an effective venue for solving coordination impediments in debt restructuring operations.

### Policy guidance: monetary, fiscal, and structural policies
- Policy responses should differ across countries, reflecting their own circumstances and exposures.
- Monetary policy:
  - Central banks should maintain a sufficiently tight, data-dependent monetary policy stance to durably reduce inflation and avoid a de-anchoring of inflation expectations.
  - Directors called on policymakers to stand ready to take strong actions to restore financial stability and reinvigorate confidence as developments demand.
  - Clear communication about policy reaction functions and objectives and the need to further normalize policy would help avoid unwarranted market volatility.
- Fiscal policy:
  - Tighter fiscal policy is needed to help contain inflationary pressures, making it possible for central banks to increase interest rates by less than otherwise, help contain governments’ borrowing costs, and ease potential tradeoffs between price and financial stability.
  - Fiscal restraint should be accompanied by temporary and carefully targeted measures to protect the most vulnerable segments.
  - Given heightened uncertainty, fiscal policy should remain flexible to respond if risks materialize.
  - To tackle elevated debt vulnerabilities and rebuild fiscal buffers, Directors called for credible medium-term fiscal frameworks and cautioned against relying on high inflation for public debt reduction.
  - In low-income developing countries, further efforts to increase tax capacity were stressed given the importance of addressing heightened debt vulnerabilities, protecting the poorest, and advancing the Sustainable Development Goals.
- Structural reforms:
  - Directors emphasized that structural reforms remain essential to improve productivity, expand economic capacity, and ease supply-side constraints.
  - Many emerging market and developing economies face tougher policy choices due to rising costs of market financing, higher food and fuel prices, and the need to support recovery and vulnerable populations.

### Financial sector stability and regulation
- Directors commended decisive policy responses to stem recent financial instability.
- Recent stress in the banking sector highlighted failures in internal risk-management practices with respect to interest rate and liquidity risks in some banks, as well as supervisory lapses.
- Recommendations and concerns:
  - Closely monitor financial sector developments, including nonbank financial intermediaries (NBFIs).
  - Improve banking regulation, supervision, and resolution frameworks.
  - Use available policies, including macroprudential policies, swiftly and appropriately if further vulnerabilities materialize, while mitigating moral hazard.
  - Recognize the important role of NBFIs and their increasing interconnectedness with banks and other financial institutions.
  - Many Directors considered that provision of central bank liquidity to NBFIs could lead to unintended consequences.
  - If liquidity provision to NBFIs is needed to address systemic risks, ensure appropriate guardrails, including robust regulation and supervision, and progress in closing regulatory data gaps in this sector remains vital.

*The following remarks were made by the Chair at the conclusion of the Executive Board’s discussion of the Fiscal Monitor, Global Financial Stability Report, and World Economic Outlook on March 30, 2023. (WORLD ECONOMIC OUTLOOK APRIL 2023)*

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_Source: https://www.imf.org/-/media/files/publications/weo/2023/april/english/text.pdf_