Strong Policy Action—The Essence of Restoring Global Economic Hope
IMF Blog, September 20, 2011
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- Authors: Olivier Blanchard
- Published: September 20, 2011
Overview and current state (as of September 20, 2011)
- Author: Olivier Blanchard
- Main assessment: The global economy has entered a dangerous new phase; the recovery has weakened considerably and downside risks have increased sharply.
- Contributing factors highlighted:
- Growth, which had been strong in 2010, decreased in 2011.
- One-time events (for example, the earthquake in Japan) contributed to slowdown but did not fully explain it.
- Financial volatility increased sharply since the middle of the summer, amplifying downside risks.
Rebalancing stalls — diagnosis
- Internal rebalancing:
- Needed: households and firms must increase demand as fiscal deficits are rolled back.
- Current impediments: tight bank lending, legacy of the housing boom, high household leverage — all exert stronger brakes on recovery than anticipated.
- External rebalancing:
- Needed: advanced countries with current account deficits (in particular the United States) must rely more on foreign demand if domestic demand remains low; emerging market countries with current account surpluses (in particular China) must shift toward domestic demand.
- Current situation: this rebalancing is not taking place; narrowing of imbalances during the crisis was driven more by cyclical factors than structural adjustment.
- Forecast implication: Looking forward, the IMF forecasts an increase, rather than a decrease, in imbalances.
Financial worries and transmission to the real economy
- Nature of financial developments:
- Markets became more skeptical about governments' ability to stabilize public debt.
- Worries spread from peripheral European countries to Europe’s core, and to Japan and the United States.
- Concerns about sovereigns translated into concerns about banks holding sovereign bonds, mainly in Europe.
- Consequences:
- Partial freeze of financial relations: banks holding high levels of liquidity and tightening lending.
- High fear of the unknown and falling stock prices.
- Expected adverse effects on spending and growth in coming months.
Growth forecasts and risks
- Revised world growth forecast: about 4% for both 2011 and 2012, down from 4.5% in both years in the April forecast.
- Distribution of 2011 growth:
- Emerging market countries: 6.4%
- Advanced countries: 1.6%
- Forecast caveat: The forecast assumes that policy commitments are met.
- Feedback risks emphasized:
- Low growth makes fiscal consolidation harder; fiscal consolidation may reduce growth further.
- Lower growth weakens banks; weaker banks lead to tighter lending and lower growth.
- Clear downside risks to the baseline forecast.
Outlook for emerging and developing countries
- To date: Largely immune to adverse developments; have managed volatile capital flows and sustained high growth.
- Going forward: May face a more difficult environment with more adverse export conditions and more volatile capital flows.
Policy prescriptions — the three main legs of decisive action
- 1) Fiscal policy:
- Fiscal consolidation must be timed: not too fast (would kill growth), not too slow (would kill credibility).
- The appropriate speed must vary across countries; key is credible medium term consolidation.
- Complementary measures to prop up domestic demand: continued low interest rates, increased bank lending, resolution programs for housing.
- 2) Financial measures:
- Banks must be made stronger to increase lending and reduce risks of vicious feedback loops.
- For a number of banks, especially in Europe, this requires additional capital buffers, preferably private, but public sources if needed.
- 3) External rebalancing:
- US domestic demand alone is unlikely to ensure sufficient US growth; the US must rely more on foreign demand (reduce its current account deficit).
- Several Asian countries with large current account surpluses, in particular China, have announced plans to rebalance from foreign to domestic demand.
- These plans cannot be implemented overnight but must be implemented as fast as possible.
Conclusion
- Only decisive movement on fiscal policy, financial repairs, and external rebalancing can restore prospects for a stronger and more robust recovery.
Source: Olivier Blanchard, September 20, 2011, Strong Policy Action—The Essence of Restoring Global Economic Hope
Content in this bundle
- 092011a
- Активные действия политики — квинтэссенция восстановления глобальной экономической надежды