## Global Economy: Continuing Recovery But Clouds on the Horizon

_IMF Blog, July 8, 2010_

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## Bibliographic details
- Authors: Olivier Blanchard
- Published: July 8, 2010

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### Overview
- Author: Olivier Blanchard
- Date: July 8, 2010
- Core message: Two opposing forces — stronger-than-expected near-term activity versus emerging fiscal and financial clouds (originating in Greece and extending to Europe) — create uncertainty for the recovery.

### Growth forecasts and recent performance
- World growth forecast for 2010: about 4½ % (revised up from April forecast of around 4¼ %).
- World growth forecast for 2011: about 4¼ % (broadly unchanged).
- Advanced countries growth forecasts: 2.6% for 2010 and 2.4% for 2011.
  - Implication: these low growth rates imply that high unemployment will remain a central issue.
- Emerging and developing economies growth forecasts: 6.8% in 2010 and 6.4% in 2011.
  - Revisions: an upward revision of 0.5% for 2010 and a small downward revision of 0.1% for 2011.
- Short-term performance: the world economy expanded at an annualized rate of over 5 % in the first quarter of 2010, with stronger-than-expected growth in the United States, Europe, Japan, Brazil, and India.
- Recent indicators suggest some slowdown of demand, but it is too early to assess significance.

### Macroeconomic implications of European fiscal/financial stress
- Trigger: worries about fiscal solvency in Greece spread to concerns about fiscal solvency elsewhere and then to banking solvency, producing financial turbulence and disruptions in market financing, including a freeze in the interbank market in Europe.
- Baseline assumption: policy responses will be adequate and will limit effects on the real economy.
- Even under adequate policy responses, four main macroeconomic implications are likely:
  - A depreciation of the Euro.
  - A tightening of bank lending, especially (but perhaps not only) in Europe.
  - The need for fiscal consolidation, which, even if well executed, is likely to affect demand and growth adversely in the short run.
  - A near-term reallocation of capital flows.

### Fiscal consolidation: timing, credibility, and design
- Rationale: fiscal stimulus in 2008–2009 was necessary; now countries must return to a sustainable fiscal path.
- Key objective: establish a credible roadmap to stabilize the ratio of debt to GDP over the medium term, with the goal of decreasing it substantially over the longer term.
  - G-20 commitment: advanced economies committed to fiscal plans that will stabilize or reduce government debt to GDP ratios by 2016.
- Two paths to credibility:
  - Passing reforms that improve medium- and long-term outlooks (example cited: increases in the retirement age in line with higher life expectancy).
  - Instituting fiscal rules (example cited: limits on the growth of spending over time).
- Guidance on timing and pace:
  - Adjustment should start soon.
  - Avoid excessive front-loading or too sharp a cut in deficits this year or next year, as that would be counterproductive given the fragile recovery and limited offset from already very accommodative monetary policy.
  - Current plans for 2011, which imply an average decrease in the cyclically adjusted deficit in advanced G-20 countries, of about 1.25%, strike the IMF as roughly appropriate.
- Noted shortfalls: many countries still lack ambitious entitlement reforms and, in many cases, better fiscal rules.

### Capital flows and emerging market policy challenges
- Prior to European problems: capital flows to emerging market countries were steadily increasing.
- Impact of European events: a partial reversal as higher risk aversion led investors to repatriate funds, decreasing capital flows to emerging markets.
- Outlook: the reversal is expected to be temporary; the trend is continuing strong capital flows to emerging market countries.
- Two policy considerations for emerging markets managing inflows:
  - These flows are largely driven by good fundamentals and likely to be long lasting; limiting their overall size through controls or fighting their exchange-rate effects through reserve accumulation may be difficult and eventually self-defeating.
  - Many emerging market countries would benefit from a shift from external to internal demand to sustain growth amid lower exports to advanced countries and to better satisfy domestic needs.
    - Achieving this requires structural reforms and exchange rate appreciations.
    - The IMF notes decisions by China to boost internal demand and allow for more flexibility of the yuan as welcome steps.

### Summary conclusions
- The IMF remains cautiously optimistic about the pace of recovery but identifies clear dangers and policy challenges.
- Key determinants of the outcome:
  - How Europe deals with fiscal and financial problems.
  - How advanced countries proceed with fiscal consolidation (timing, pace, credibility).
  - How emerging countries rebalance their economies toward more internal demand.

*Olivier Blanchard, July 8, 2010 — Global Economy: Continuing Recovery But Clouds on the Horizon*

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## References

- [World Economic Outlook](http://www.imf.org/external/pubs/ft/weo/2010/update/02/index.htm)

_Source: https://www.imf.org/en/blogs/articles/2010/07/08/global-economy-continuing-recovery-but-clouds-on-the-horizon_