Global Economy: Some Bad News and Some Hope

IMF Blog, October 9, 2012

Source details

The world economic recovery continues, but it has weakened further.
Relative to the IMF's forecasts last April, growth forecasts for 2013 have been revised down from 1.8% to 1.5% for advanced countries, and from 5.8% down to 5.6% for emerging and developing countries.
The downward revisions are widespread, and are stronger for two sets of countries: members of the euro area, where we now expect growth close to zero in 2013, and for three large emerging market economies, China, India, and Brazil.

Upward force on growth:
- Accommodative monetary policy: central banks maintain very low policy rates and experiment with programs to decrease rates in particular markets, help particular categories of borrowers, or help financial intermediation in general.
Downward forces on growth:
- Fiscal consolidation: proceeding according to plan in most countries, but weighing on demand; evidence suggests that, in the current environment, fiscal multipliers are large—larger than in normal times.
- Weak financial systems: banks remain weak in many countries (more so in Europe than in the United States), exacerbated by low growth, leading many borrowers to face tight borrowing conditions.
- General uncertainty: worries about European policymakers' ability to control the euro crisis, U.S. policymakers' failure to agree on a fiscal plan, and Japanese policymakers' ability to reduce their budget deficit further.

Interconnections:
- Low growth in advanced countries affects emerging and developing economies through exports and supply chains.
- Example: lower exports account for most of the decrease in growth in China; supply-chain effects account for much of the decrease in growth in Asia.
Capital flows:
- Alternative risk-off and risk-on episodes, triggered by progress and regress on policy actions, cause volatile capital flows, in particular to Asia and to Latin America.
Domestic factors:
- Policy uncertainty in India affecting domestic demand.
- Tighter policies in Brazil in response to an earlier boom.
Outlook:
- These developments are not seen as signs of a hard landing in China, India, or Brazil; positive policy measures are being taken in all three countries.
- Nonetheless, the result is expected to be lower growth for some time, lower than recent past growth.

Recent change in attitudes: realization that an ambitious architecture must be put in place.
Lessons identified:
- Euro area countries can be hit by strong shocks.
- Weak banks can considerably amplify adverse effects of shocks.
- Sovereign/bank interactions can further worsen outcomes if the sovereign itself might be in trouble.
Objectives for new architecture:
- Reduce the amplitude of shocks in the first place.
- Put in place a system of transfers to soften the effects of shocks.
- Move supervision, resolution, and recapitalization processes of banks to the euro level.
Progress:
- These issues are being seriously explored and some mechanisms are being put together.

Immediate needs for Spain and Italy:
- Follow through with adjustment plans that reestablish competitiveness and fiscal balance while maintaining growth.
- Be able to recapitalize banks, if needed, without adding to sovereign debt.
- Be able to borrow at reasonable rates.
Outlook if measures are implemented rapidly:
- If the complex puzzle of mechanisms and measures can be rapidly completed, one can reasonably hope that the worst might be behind us.
- If uncertainty is partly behind the slowdown and adoption/implementation of measures reduces it, outcomes may be better than the forecasts.
- "The case for an upside scenario is a bit stronger than it has been for a while."

Olivier Blanchard, October 9, 2012 — Global Economy: Some Bad News and Some Hope