World Faces Serious New Economic Challenges

IMF Blog, April 21, 2010

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Global growth forecast: 4.2% in 2010 (upward revision of 0.3% from January forecast) and 4.3% in 2011.
Global trade and capital flows: strong rebound.
Financial market conditions and stability: improved (as discussed in the newly released Global Financial Stability Report).
Recovery is asymmetric: tepid recovery in many advanced economies versus much stronger recovery in most emerging and developing economies.

Growth forecasts: 2.3% for 2010 and 2.4% in 2011.
Output gap: output is now 7% below its pre-crisis trend; this “output gap” is expected to remain large for many years.
Unemployment forecasts: 8.4% in 2010 and 8.0% in 2011.
Main factor behind weak performance: weak private demand.
- United States: consumers are being more prudent.
- Europe: weak banking sector limits credit supply.
- Japan: reappearance of deflation leading to higher real interest rates and endangering recovery.
Policy priority shift: from emergency fiscal stimulus to fiscal consolidation to contain risks of a debt explosion caused by loss in fiscal revenues associated with the loss in output.

Growth forecasts: 6.3% in 2010 and 6.4% in 2011.
Developing Asia: forecasts of 8.7% for 2010 and 8.6% in 2011.
Demand composition: while fiscal policy supported activity in 2009, private demand is strengthening and can sustain growth.
Main challenge: large capital inflows driven by higher growth prospects and higher interest rates.
- Risks: booms and busts from large inflows.
- Policy issues for recipients: how to accommodate flows; how much to let the currency appreciate; how to use macroeconomic policy, macro-prudential tools, reserves, and capital controls to avoid excesses and maintain stable growth.

Interaction between advanced and emerging economies:
- Advanced economies need fiscal consolidation, which is likely to reduce domestic demand and adversely affect growth.
- To offset adverse demand effects and maintain growth, advanced countries, as a whole, may need to depreciate their currency to increase net exports.
- This implies emerging and developing countries, as a whole, should allow their currencies to appreciate and reduce net exports to support global rebalancing.
National example:
- China: a shift away from exports toward domestic consumption is desirable; this requires structural measures to decrease saving and an appreciation of the currency.

Advanced economies:
- Prioritize fiscal consolidation to avoid a debt explosion.
- Manage the adverse effects of consolidation on demand, potentially through exchange rate adjustments (depreciation as a group).
Emerging and developing economies:
- Manage large capital inflows to avoid booms and busts.
- Use a mix of tools: allow currency appreciation where appropriate, apply macroeconomic policy, deploy macro-prudential measures, build reserves, and consider capital controls if needed.
- Pursue structural reforms to rebalance demand toward domestic consumption (example cited: China).
Global coordination:
- Recognize that exchange rate adjustments and demand rebalancing across countries are interconnected and in the global interest to sustain balanced growth.

Outcome to date: a global depression has been averted; the world economy is recovering and better than previously expected.
New challenges: achieving strong, sustained and balanced growth will require fiscal consolidation in advanced countries, exchange rate adjustments, and a rebalancing of demand across the world.
Time horizon: these are the tasks facing policymakers over the next few years.

Source: Olivier Blanchard, April 21, 2010 — World Faces Serious New Economic Challenges