Global Recovery Strengthens, Tensions Heighten

IMF Blog, April 11, 2011

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World economy expected to grow at about 4.5 percent a year in both 2011 and 2012.
Advanced economies expected to grow at only 2.5 percent.
Emerging and developing economies expected to grow at 6.5 percent.

Earlier fears of a double dip have not materialized.
In advanced economies:
- Inventory cycle is largely over.
- Fiscal stimulus has turned to fiscal consolidation.
- Private demand has, for the most part, taken up the relay.
Commodity prices have increased more than expected due to strong demand growth and a number of supply shocks; these increases appear unlikely to derail the recovery.
In advanced countries, factors limiting the impact of commodity price rises include:
- Decreasing share of oil.
- Disappearance of wage indexation.
- Anchoring of inflation expectations.

Concern about commodity-price-driven stagflation reminiscent of the 1970s, though judged unlikely to derail recovery.
In emerging market and developing countries:
- Larger share of food in consumption.
- Credibility of monetary policy often weaker.
- Inflation may well be higher for some time, but forecasts do not expect a major adverse effect on growth.
In most advanced economies:
- Output is still far below potential.
- Unemployment is high and likely to remain so for many years.
- Low growth stems from pre-crisis excesses and crisis wounds.
- In the United States, the housing market remains depressed, leading to anemic housing investment.
- Fiscal positions deteriorated, forcing fiscal consolidation while market worries about fiscal sustainability persist.
- Banks are struggling to achieve higher capital ratios amid increasing non-performing loans.
Europe’s periphery faces particularly acute problems from the combined effects of low growth, fiscal woes, and financial pressures; reestablishing fiscal and financial sustainability amid low or negative growth and high interest rates is a substantial challenge.
Underlying low rates of potential output make adjustment very hard when growth is very low.

Increase clarity on banks’ exposures with ready recapitalization plans if and where needed.
Implement smart fiscal consolidation that is neither too fast (which could kill growth) nor too slow (which would kill credibility).
Redesign financial regulation and supervision.
Especially in Europe, increase focus on reforms to raise potential growth.

Recognize the crisis left fewer lasting wounds; typically stronger initial fiscal and financial positions and more muted adverse effects.
High underlying growth and low interest rates are easing fiscal adjustment.
Exports have largely recovered; shortfalls in external demand typically offset by increased domestic demand.
Capital outflows have turned into capital inflows due to better growth prospects and higher interest rates than in advanced countries.
To avoid overheating amid closing output gaps and higher capital flows, countries should:
- Rely on a combination of higher interest rates and fiscal consolidation to maintain output at potential.
- Use a mix of reserve accumulation and macroprudential tools, including, where needed, capital controls, to avoid increases in systemic risk stemming from inflows.
- Accept exchange rate appreciation as part of desirable adjustment, since appreciation increases real income and should not be resisted.

Advanced countries must reduce government deficits and debt levels; to do so and maintain growth they need to rely more on external demand.
Emerging market countries must rely less on external demand and more on domestic demand.
Appreciation of emerging market currencies relative to advanced countries’ currencies is an important key to global adjustment.
Careful national policy design and global coordination remain as important now as at the peak of the crisis two years ago.

By Olivier Blanchard — April 11, 2011