IMF Survey: Close Ties Led to Crisis in World’s Five Major Economies

IMF News, September 21, 2009

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Integrated financial and banking systems and close trade ties were major factors in spreading the worst financial crisis in 60 years, according to a new IMF study.
The study reviews IMF reports on the world’s five major economies—the United States, the euro area, China, Japan, and the United Kingdom—based on discussions IMF officials had with the governments during May and June 2009.
These five economies together account for more than half of global output, 70 percent of net global financial flows, and almost two thirds of global saving.

Finding: The United States, the United Kingdom, and the euro area together account for over two-thirds of global gross capital flows and their financial sectors are closely linked; bank problems in the United States spread almost immediately to Europe.
Finding: China and Japan had limited international financial integration and were not directly exposed to the toxic assets originating from the United States, which helped contain direct impact on local banks.
Finding: China and Japan were hit primarily through trade—collapse in world trade driven by lower consumer spending in Europe and the United States on highly traded consumer durables and investment goods affected these export-oriented economies.

Finding: Policymakers calibrated responses—liquidity support, bank support, and fiscal stimulus—to country circumstances.
Finding: For the United States and Europe, the risk of almost instantaneous market reactions produced a disorganized rush to protect national banks, in contrast to a more coordinated monetary and fiscal response.
Finding: Asia responded more with traditional macroeconomic measures, focused on fiscal stimulus.
Finding: Institutional features and policy settings (how central banks are run; strength of automatic stabilizers in public finances) materially shaped country-specific responses.

Finding: Withdrawal of monetary and fiscal stimulus will be needed in all five economies as soon as clear signs of a lasting recovery emerge.
Finding: Unwinding unconventional monetary policies is expected to occur organically in most countries, but some central banks may not be able to devolve assets because markets for them remain frozen.
Finding: All five economies face the challenge of putting in place credible fiscal consolidation plans and avoiding premature tightening that could choke recovery.
Recommendation: Reverse financial sector support measures gradually; coordination across countries may be needed to minimize market disruption.

Finding: Medium-term projections across the five economies suggest a rising discrepancy between major countries’ output and demand, raising the risk of a deficiency of demand and a weak recovery.
Recommendation: To minimize the risk of weak global demand, China and Japan need to redouble efforts to boost private domestic demand to make up for the retrenchment of spending elsewhere caused by the financial crisis.
Recommendation: This may require, among other policy measures, an appreciation of the renminbi against the dollar, euro and sterling.

Source: IMF Survey: Close Ties Led to Crisis in World’s Five Major Economies (IMF Survey online, September 21, 2009).