## _041812b

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---

### Key Points
- After suffering a major setback, global prospects are gradually strengthening again.
- Improved activity in the United States and better policies in the euro area have reduced the immediate threat of a sharp global slowdown.
- Weak recovery is likely to resume in the major advanced economies, and activity should remain relatively solid in emerging market and developing economies.
- The recovery remains fragile, and risks are firmly to the downside:
  - Most immediate concern: renewed escalation of the euro area crisis.
  - Geopolitical uncertainty could sharply increase oil prices and undermine world growth.
  - Medium-term risks: persistently weak activity and high public deficits and debt in advanced economies; overly optimistic expectations and strong credit growth in various emerging market economies.
- Without a stronger policy response, the period of relative stability could be fleeting and be followed by prolonged stagnation.
- Multilateral action needs to complement national action; raising the IMF’s lending capacity would help stem risks and facilitate a durable exit from the crisis.

### Policy Advice Summary
- Advanced economies:
  - Measured near-term fiscal consolidation, including fiscal policies that do the least harm to demand in the short term:
    - (i) Raising high-multiplier spending and cutting low-multiplier spending or raising low-multiplier taxes in a budget-neutral manner.
    - (ii) Allowing automatic stabilizers to operate freely, if market conditions permit.
    - (iii) Consider slower adjustment, if credibility with markets is strong and sufficient policy space to do so is available.
  - Medium-term fiscal consolidation, entitlement reform, better fiscal rules and institutions.
  - Accommodative monetary and liquidity policies; unconventional support as needed to limit risks for debt–deflation traps.
  - Structural reforms to boost long-term productivity and employment.
  - Support for the unemployed.
- Euro area economies:
  - Build a stronger currency union with institutional and governance reforms and structural reforms that facilitate internal demand rebalancing.
  - Strengthen banking systems by raising capital while avoiding a credit crunch.
- Emerging market and developing economies:
  - Rebuild macroeconomic policy room.
  - Strengthen prudential policies and frameworks to deal with greater capital flow volatility.
  - Promote more inclusive growth.
- Economies with large external surpluses:
  - Foster domestic consumption, including with more exchange rate flexibility.
- All economies:
  - More coordination of financial policies; reform of financial stability frameworks.
  - Strengthen the global firewall.

### The Global Conjuncture — Findings and Projections
- Recent events:
  - Intense sovereign debt market pressure and the freezing of bank funding markets in November 2011 threatened a deep recession.
  - Stabilizing measures included decisive ECB long-term liquidity, fiscal adjustment and structural reforms by key euro area members, improvements in EU governance, completion of the Greek debt exchange, and the agreed combination of the ESM and the EFSF.
- Financial sector stresses:
  - Pressures on the European banking sector remain intense: sovereign stress, weak growth, high rollover requirements, and the need to increase capital.
  - Banks have engaged in broad-based efforts to shrink balance sheets, thereby squeezing bank asset holdings and contributing to pressure on euro area credit supply.
  - These effects are compounded by synchronized and front-loaded fiscal consolidation by many euro area governments.
- Labor markets and prices:
  - Rising oil prices are reducing household disposable incomes.
  - Unemployment remains high and a large and growing fraction is long-term.
- Growth projections:
  - Advanced economies: activity is projected to expand by only 1½ percent in 2012 and 2 percent in 2013.
  - Unemployment rates in advanced economies are expected to remain around 7¾ percent in 2013.
  - Emerging market and developing economies: growth is projected at 5¾ percent in 2012 and 6 percent in 2013.
- Capital flows: swings in sentiment due to events in Europe have increased the volatility of exchange rates and capital flows to emerging market economies.

### Key Risks
- Overall: the global economy remains unusually vulnerable despite reduced immediate risks.
- Risk 1 — Sovereign stress and bank deleveraging in the euro area:
  - Failure to revive growth or poor policy implementation could re-intensify adverse feedback loops between sovereign risk and bank balance sheets.
  - Rising sovereign spreads could force immediate fiscal consolidation, depressing demand and growth and initiating a vicious cycle of tightening and lower growth.
  - Losses on sovereign debt holdings and loans could weaken bank balance sheets and elevate funding costs, prompting large-scale deleveraging and substantial tightening of credit supply.
  - A "weak policies scenario" illustrates potential deleveraging among EU banks and spillovers globally.
  - Euro area output could be lower by about 3½ percent and global output by about 2 percent, relative to WEO projections.
- Risk 2 — Oil supply disruptions:
  - A halt of the Islamic Republic of Iran’s exports to OECD economies (if not offset) would likely trigger an initial oil price increase of about 20 to 30 percent, with partial offset over time from other producers or emergency stock releases.
  - Further uncertainty could trigger a much larger price spike. Model simulations suggest that a hike in the oil price by about 50 percent would lower global output by about 1¼ percent or more relative to WEO projections.
  - The decline depends on spillovers to confidence and financial markets, undermining recovery in advanced economies and squeezing budgets in emerging market and developing economies with extensive energy subsidies.
- Additional downside risk: weak medium-term growth could undercut support for fiscal adjustment and for trade and financial integration, increasing volatility in global bond and currency markets and compounding concerns about high public deficits and debt in the United States and Japan. Growth could also disappoint in key emerging market economies as credit and investment booms peter out.

### Policy Advice — Detailed Guidance
- Priorities for advanced economies:
  - Rebuild financial stability and implement fundamental reforms to prioritize growth.
  - Address high debt burdens that constrain fiscal policy while acknowledging monetary policy proximity to the zero lower bound.
  - Adopt structural, productivity-enhancing reforms to avoid prolonged tepid growth and small employment gains.
- Monetary and liquidity policy:
  - Continue supportive monetary and liquidity policies; avoid overstating inflation risks from unconventional monetary policy that would limit central bank options.
  - Use unconventional policies to limit the risk of major economies falling into debt-deflation traps.
  - Monetary policymakers should focus beyond headline inflation to potential transmission to wages, which is unlikely given high unemployment.
- Fiscal consolidation approach:
  - High deficits, rising debt ratios, and market volatility argue for consolidation—but at a measured pace given weak activity.
  - Avoid excessive short-term consolidation that could worsen debt ratios by depressing growth.
  - Adopt fiscal policies that do the least harm to demand in the short term:
    - Support output growth while keeping consolidation on track via temporary tax hikes matched by budget-neutral increases in government spending targeted toward productive investment and support for distressed households.
    - Countries with fiscal room should let automatic stabilizers operate freely.
    - Countries with policy maneuvering room and sufficient credibility can reconsider the pace of consolidation.
  - Short-term flexibility should not postpone adoption of strong medium-term consolidation plans.
- Structural reforms to support long-term growth and fiscal sustainability:
  - Strengthen fiscal institutions and reform entitlement programs (e.g., linking retirement age to life expectancy; improving incentives in health care).
  - Reforms to labor and product markets, including income support and training for the unemployed, to raise productivity and increase labor force participation.
  - Policies to encourage bank lending to small and medium-sized enterprises.
  - Address long-term unemployment to protect pension system viability and social cohesion.
  - Policies directed at real estate markets can accelerate household balance sheet improvement and support consumption; examples cited include Iceland and U.S. administrative programs.

### Euro area: restoring short-term stability and strengthening the union
- Short-term stability measures risk losing effectiveness unless followed by medium-term steps to create a stronger currency union.
- Key elements and recommendations:
  - The recently agreed combination of the ESM and the EFSF, along with other recent European efforts, will strengthen the European firewall.
  - During periods of acute stress, the ECB must continue to stand ready to intervene to maintain orderly conditions in bond markets and thereby facilitate the pass-through of monetary policy to the real economy.
  - Complementary fiscal mechanism: a strong mechanism that delivers responsible fiscal policies is required; the recently-agreed "fiscal compact" marks important progress with little detriment to fiscal flexibility.
  - Enforcement may require EU institutions to be actively involved in national budgetary plans, as envisaged by current proposals (the "two pack").
  - The "fiscal compact" will also need to be complemented by greater fiscal risk sharing to ensure that economic dislocation in one country does not develop into a costly fiscal and financial crisis for the entire region.
- Banking and financial stability:
  - Nonviable banks—whose continued existence allows problems to fester—need to be resolved.
  - Viable banks need continued access to strong funding support through either the ECB or a centralized program.
  - Close, coordinated oversight by the European Systemic Risk Board and European Banking Authority, along with national regulators, is needed to ensure that deleveraging is accomplished by raising capital and does not result in a credit crunch.
  - Develop a road map for a complete euro-area-wide financial stability framework to break the link between weak sovereigns and banks; elements include greater fiscal risk sharing conditional on more centralized fiscal governance, and centralized power over bank supervision and regulation, deposit insurance, and bank resolution, funded by common backstops.
- Real and structural adjustment:
  - Need for better adjustment to real as well as fiscal and financial imbalances.
  - Periphery economies are implementing major structural reforms, especially to labor markets; progress in these domains is essential for a well-functioning monetary union.

### Emerging market and developing economies: balancing near-term risks and rebuilding policy space
- Context: many economies enjoyed a strong decade supported by rapid credit growth or high commodity prices; cautions and policy guidance:
  - Credit growth that reflects financial deepening can be positive, but in various economies credit cannot continue to expand at its present pace without raising serious concerns about the quality of bank lending.
  - Commodity prices are unlikely to grow at the elevated pace witnessed over the past decade; fiscal and other policies may need to adapt to lower potential output growth to avoid overstimulating activity.
- Policy recommendations (tailored by country circumstances):
  - Many economies should continue to rebuild macroeconomic policy room and strengthen prudential policies and frameworks.
  - For economies that have largely normalized macroeconomic policies, the near-term focus should be on responding to lower external demand from advanced economies.
  - Monetary policymakers need to be vigilant that oil price hikes do not translate into broader inflation pressure, and fiscal policy must contain damage to public sector balance sheets by targeting subsidies only to the most vulnerable households.
  - Strengthened prudential policies are needed to mitigate risks from swings in sentiment and associated economic and financial volatility stemming from developments in advanced economies.
  - Emerging surplus economies, particularly China, would benefit from greater home-grown sources of growth that rely less on very high investment; policies should promote a continued shift from external to domestic demand, likely requiring, among other measures, exchange rate adjustment, and should facilitate a shift from investment to consumption to advance global demand rebalancing.

### Multilateral action and global coordination
- Use the breathing space offered by markets to get ahead of the crisis; coordinated intervention can rebuild confidence and foster growth, potentially creating a virtuous cycle (lower sovereign yields, reduced stress on bank balance sheets, less deleveraging pressure).
- "Complete policies scenario" (illustrative assumptions and outcomes):
  - Assumes policies foster a larger-than-expected easing in euro-area banking and sovereign stress.
  - Outside the euro area, credit conditions also improve, most notably in the United States, where lending to small and medium-size firms is assumed to pick up much more quickly than in the WEO projections.
  - Geopolitical tensions are assumed to ease, with the price of oil assumed to be roughly 10 percent below that in the baseline.
  - Under this scenario, global GDP is roughly 1½ percent higher than in WEO projections, led by an improvement of almost 2¼ percent in the euro area.
  - Emerging market and developing economies would benefit through stronger foreign demand and likely lower volatility in capital flows.
- For a virtuous cycle, policy actions need to be mutually reinforcing and geared toward generating positive spillovers; complementing a stronger euro-area firewall with a stronger global firewall is a key measure.
- More coordination of financial policies and frameworks:
  - Main global challenge is consistent implementation of the new consensus regulations (such as Basel III) and addressing other financial sector weaknesses revealed by the crisis (institutions too big or too complex to fail, large financial institutions outside the regulatory net, and cross-border collaboration between bank supervisors).
  - Without consistent implementation, financial institutions may engage in regulatory arbitrage and undermine prudential controls.
- Shared responsibility for global aggregate demand:
  - Austerity alone cannot treat the economic malaise in major advanced economies.
  - Countries with easy access to market funding should not fiscally adjust as much as countries without access to market funding.
  - Countries with high saving rates should address distortions that weigh on consumption; those with too much credit-driven growth must do the opposite.
  - All countries need to work toward creating a stronger international monetary and financial system to enable positive spillovers and feedback loops that can solidify global demand, promote employment, and more inclusive growth.

*Source: Consolidated Multilateral Surveillance Report — Section 1 (April 2012), International Monetary Fund; _041812b - Section 2.*

### Section 1

### Consolidated Multilateral Surveillance Report — Section 1

### Key Points
- After suffering a major setback, global prospects are gradually strengthening again.
- Improved activity in the United States and better policies in the euro area have reduced the immediate threat of a sharp global slowdown.
- Weak recovery is likely to resume in the major advanced economies, and activity should remain relatively solid in emerging market and developing economies.
- The recovery remains fragile, and risks are firmly to the downside:
  - Most immediate concern: renewed escalation of the euro area crisis.
  - Geopolitical uncertainty could sharply increase oil prices and undermine world growth.
  - Medium-term risks: persistently weak activity and high public deficits and debt in advanced economies; overly optimistic expectations and strong credit growth in various emerging market economies.
- Without a stronger policy response, the period of relative stability could be fleeting and be followed by prolonged stagnation.
- Multilateral action needs to complement national action; raising the IMF’s lending capacity would help stem risks and facilitate a durable exit from the crisis.

### Policy Advice Summary
- Advanced economies:
  - Measured near-term fiscal consolidation, including fiscal policies that do the least harm to demand in the short term:
    - (i) Raising high-multiplier spending and cutting low-multiplier spending or raising low-multiplier taxes in a budget-neutral manner.
    - (ii) Allowing automatic stabilizers to operate freely, if market conditions permit.
    - (iii) Consider slower adjustment, if credibility with markets is strong and sufficient policy space to do so is available.
  - Medium-term fiscal consolidation, entitlement reform, better fiscal rules and institutions.
  - Accommodative monetary and liquidity policies; unconventional support as needed to limit risks for debt–deflation traps.
  - Structural reforms to boost long-term productivity and employment.
  - Support for the unemployed.
- Euro area economies:
  - Build a stronger currency union with institutional and governance reforms and structural reforms that facilitate internal demand rebalancing.
  - Strengthen banking systems by raising capital while avoiding a credit crunch.
- Emerging market and developing economies:
  - Rebuild macroeconomic policy room.
  - Strengthen prudential policies and frameworks to deal with greater capital flow volatility.
  - Promote more inclusive growth.
- Economies with large external surpluses:
  - Foster domestic consumption, including with more exchange rate flexibility.
- All economies:
  - More coordination of financial policies; reform of financial stability frameworks.
  - Strengthen the global firewall.

### The Global Conjuncture — Findings and Projections
- Recent events:
  - Intense sovereign debt market pressure and the freezing of bank funding markets in November 2011 threatened a deep recession.
  - Stabilizing measures included decisive ECB long-term liquidity, fiscal adjustment and structural reforms by key euro area members, improvements in EU governance, completion of the Greek debt exchange, and the agreed combination of the ESM and the EFSF.
- Financial sector stresses:
  - Pressures on the European banking sector remain intense: sovereign stress, weak growth, high rollover requirements, and the need to increase capital.
  - Banks have engaged in broad-based efforts to shrink balance sheets, thereby squeezing bank asset holdings and contributing to pressure on euro area credit supply.
  - These effects are compounded by synchronized and front-loaded fiscal consolidation by many euro area governments.
- Labor markets and prices:
  - Rising oil prices are reducing household disposable incomes.
  - Unemployment remains high and a large and growing fraction is long-term.
- Growth projections:
  - Advanced economies: activity is projected to expand by only 1½ percent in 2012 and 2 percent in 2013.
  - Unemployment rates in advanced economies are expected to remain around 7¾ percent in 2013.
  - Emerging market and developing economies: growth is projected at 5¾ percent in 2012 and 6 percent in 2013.
- Capital flows: swings in sentiment due to events in Europe have increased the volatility of exchange rates and capital flows to emerging market economies.

### Key Risks
- Overall: the global economy remains unusually vulnerable despite reduced immediate risks.
- Risk 1 — Sovereign stress and bank deleveraging in the euro area:
  - Failure to revive growth or poor policy implementation could re-intensify adverse feedback loops between sovereign risk and bank balance sheets.
  - Rising sovereign spreads could force immediate fiscal consolidation, depressing demand and growth and initiating a vicious cycle of tightening and lower growth.
  - Losses on sovereign debt holdings and loans could weaken bank balance sheets and elevate funding costs, prompting large-scale deleveraging and substantial tightening of credit supply.
  - A "weak policies scenario" illustrates potential deleveraging among EU banks and spillovers globally.
  - Euro area output could be lower by about 3½ percent and global output by about 2 percent, relative to WEO projections.
- Risk 2 — Oil supply disruptions:
  - A halt of the Islamic Republic of Iran’s exports to OECD economies (if not offset) would likely trigger an initial oil price increase of about 20 to 30 percent, with partial offset over time from other producers or emergency stock releases.
  - Further uncertainty could trigger a much larger price spike. Model simulations suggest that a hike in the oil price by about 50 percent would lower global output by about 1¼ percent or more relative to WEO projections.
  - The decline depends on spillovers to confidence and financial markets, undermining recovery in advanced economies and squeezing budgets in emerging market and developing economies with extensive energy subsidies.
- Additional downside risk: weak medium-term growth could undercut support for fiscal adjustment and for trade and financial integration, increasing volatility in global bond and currency markets and compounding concerns about high public deficits and debt in the United States and Japan. Growth could also disappoint in key emerging market economies as credit and investment booms peter out.

### Policy Advice — Detailed Guidance
- Priorities for advanced economies:
  - Rebuild financial stability and implement fundamental reforms to prioritize growth.
  - Address high debt burdens that constrain fiscal policy while acknowledging monetary policy proximity to the zero lower bound.
  - Adopt structural, productivity-enhancing reforms to avoid prolonged tepid growth and small employment gains.
- Monetary and liquidity policy:
  - Continue supportive monetary and liquidity policies; avoid overstating inflation risks from unconventional monetary policy that would limit central bank options.
  - Use unconventional policies to limit the risk of major economies falling into debt-deflation traps.
  - Monetary policymakers should focus beyond headline inflation to potential transmission to wages, which is unlikely given high unemployment.
- Fiscal consolidation approach:
  - High deficits, rising debt ratios, and market volatility argue for consolidation—but at a measured pace given weak activity.
  - Avoid excessive short-term consolidation that could worsen debt ratios by depressing growth.
  - Adopt fiscal policies that do the least harm to demand in the short term:
    - Support output growth while keeping consolidation on track via temporary tax hikes matched by budget-neutral increases in government spending targeted toward productive investment and support for distressed households.
    - Countries with fiscal room should let automatic stabilizers operate freely.
    - Countries with policy maneuvering room and sufficient credibility can reconsider the pace of consolidation.
  - Short-term flexibility should not postpone adoption of strong medium-term consolidation plans.
- Structural reforms to support long-term growth and fiscal sustainability:
  - Strengthen fiscal institutions and reform entitlement programs (e.g., linking retirement age to life expectancy; improving incentives in health care).
  - Reforms to labor and product markets, including income support and training for the unemployed, to raise productivity and increase labor force participation.
  - Policies to encourage bank lending to small and medium-sized enterprises.
  - Address long-term unemployment to protect pension system viability and social cohesion.
  - Policies directed at real estate markets can accelerate household balance sheet improvement and support consumption; examples cited include Iceland and U.S. administrative programs.

*Source: Consolidated Multilateral Surveillance Report — Section 1 (April 2012), International Monetary Fund.*

### Section 2

### _041812b - Section 2

### Euro area: restoring short-term stability and strengthening the union
- Short-term stability measures risk losing effectiveness unless followed by medium-term steps to create a stronger currency union.
- Key elements and recommendations:
  - The recently agreed combination of the ESM and the EFSF, along with other recent European efforts, will strengthen the European firewall.
  - During periods of acute stress, the ECB must continue to stand ready to intervene to maintain orderly conditions in bond markets and thereby facilitate the pass-through of monetary policy to the real economy.
  - Complementary fiscal mechanism: a strong mechanism that delivers responsible fiscal policies is required; the recently-agreed "fiscal compact" marks important progress with little detriment to fiscal flexibility.
  - Enforcement may require EU institutions to be actively involved in national budgetary plans, as envisaged by current proposals (the "two pack").
  - The "fiscal compact" will also need to be complemented by greater fiscal risk sharing to ensure that economic dislocation in one country does not develop into a costly fiscal and financial crisis for the entire region.
- Banking and financial stability:
  - Nonviable banks—whose continued existence allows problems to fester—need to be resolved.
  - Viable banks need continued access to strong funding support through either the ECB or a centralized program.
  - Close, coordinated oversight by the European Systemic Risk Board and European Banking Authority, along with national regulators, is needed to ensure that deleveraging is accomplished by raising capital and does not result in a credit crunch.
  - Develop a road map for a complete euro-area-wide financial stability framework to break the link between weak sovereigns and banks; elements include greater fiscal risk sharing conditional on more centralized fiscal governance, and centralized power over bank supervision and regulation, deposit insurance, and bank resolution, funded by common backstops.
- Real and structural adjustment:
  - Need for better adjustment to real as well as fiscal and financial imbalances.
  - Periphery economies are implementing major structural reforms, especially to labor markets; progress in these domains is essential for a well-functioning monetary union.

### Emerging market and developing economies: balancing near-term risks and rebuilding policy space
- Context: many economies enjoyed a strong decade supported by rapid credit growth or high commodity prices; cautions and policy guidance:
  - Credit growth that reflects financial deepening can be positive, but in various economies credit cannot continue to expand at its present pace without raising serious concerns about the quality of bank lending.
  - Commodity prices are unlikely to grow at the elevated pace witnessed over the past decade; fiscal and other policies may need to adapt to lower potential output growth to avoid overstimulating activity.
- Policy recommendations (tailored by country circumstances):
  - Many economies should continue to rebuild macroeconomic policy room and strengthen prudential policies and frameworks.
  - For economies that have largely normalized macroeconomic policies, the near-term focus should be on responding to lower external demand from advanced economies.
  - Monetary policymakers need to be vigilant that oil price hikes do not translate into broader inflation pressure, and fiscal policy must contain damage to public sector balance sheets by targeting subsidies only to the most vulnerable households.
  - Strengthened prudential policies are needed to mitigate risks from swings in sentiment and associated economic and financial volatility stemming from developments in advanced economies.
  - Emerging surplus economies, particularly China, would benefit from greater home-grown sources of growth that rely less on very high investment; policies should promote a continued shift from external to domestic demand, likely requiring, among other measures, exchange rate adjustment, and should facilitate a shift from investment to consumption to advance global demand rebalancing.

### Multilateral action and global coordination
- Use the breathing space offered by markets to get ahead of the crisis; coordinated intervention can rebuild confidence and foster growth, potentially creating a virtuous cycle (lower sovereign yields, reduced stress on bank balance sheets, less deleveraging pressure).
- "Complete policies scenario" (illustrative assumptions and outcomes):
  - Assumes policies foster a larger-than-expected easing in euro-area banking and sovereign stress.
  - Outside the euro area, credit conditions also improve, most notably in the United States, where lending to small and medium-size firms is assumed to pick up much more quickly than in the WEO projections.
  - Geopolitical tensions are assumed to ease, with the price of oil assumed to be roughly 10 percent below that in the baseline.
  - Under this scenario, global GDP is roughly 1½ percent higher than in WEO projections, led by an improvement of almost 2¼ percent in the euro area.
  - Emerging market and developing economies would benefit through stronger foreign demand and likely lower volatility in capital flows.
- For a virtuous cycle, policy actions need to be mutually reinforcing and geared toward generating positive spillovers; complementing a stronger euro-area firewall with a stronger global firewall is a key measure.
- More coordination of financial policies and frameworks:
  - Main global challenge is consistent implementation of the new consensus regulations (such as Basel III) and addressing other financial sector weaknesses revealed by the crisis (institutions too big or too complex to fail, large financial institutions outside the regulatory net, and cross-border collaboration between bank supervisors).
  - Without consistent implementation, financial institutions may engage in regulatory arbitrage and undermine prudential controls.
- Shared responsibility for global aggregate demand:
  - Austerity alone cannot treat the economic malaise in major advanced economies.
  - Countries with easy access to market funding should not fiscally adjust as much as countries without access to market funding.
  - Countries with high saving rates should address distortions that weigh on consumption; those with too much credit-driven growth must do the opposite.
  - All countries need to work toward creating a stronger international monetary and financial system to enable positive spillovers and feedback loops that can solidify global demand, promote employment, and more inclusive growth.

*Source: _041812b - Section 2*

---


_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2012/_041812b.pdf_