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- Assumptions and Conventions
- Joint Foreword to World Economic Outlook and Global Financial Stability Report
- Executive Summary
- Chapter 1. Global Prospects and Policies
- Recovery Is Stronger than Expected, but Speed Varies
- Financial Conditions Are Easing, but Not for All Sectors
- Capital Is Again Flowing to Emerging Economies
- Policy Support Has Been Essential in Fostering Recovery
- Multispeed Recovery to Continue during 2010–11
- Inflation Pressures Are Generally Subdued but Diverge
- Important Risks Remain amid Sharply Diminished Room for Policy Maneuvers
- Policies Need to Sustain and Strengthen Recovery
- Global Demand Rebalancing: The Role of Credibility and Policy Coordination
- Appendix 1.1. Commodity Market Developments and Prospects
- Chapter 2. Country and Regional Perspectives
- A Stimulus-Driven U.S. Recovery Is under Way
- Asia Is Staging a Vigorous and Balanced Recovery
- Europe Is Facing an Uneven Recovery and Complex Policy Challenges
- The CIS Economies Are Recovering at a Moderate Pace
- Latin America and the Caribbean Are Recovering at a Robust Pace
- The Middle East and North Africa Region Is Recovering at a Good Pace
- Africa Is Coming through the Crisis Well
- Chapter 3. Unemployment Dynamics during Recessions and Recoveries: Okun’s Law and Beyond
- Broad Labor Market Dynamics during the Great Recession
- Using Okun’s Law as a Framework
- Step 1: Okun’s Law across Countries and over Time
- Step 2: Analyzing Unemployment Rate “Forecast Errors”
- The Key Issues: Drivers of Great Recession Dynamics and Recovery Prospects
- Conclusions and Implications for the Recovery
- Appendix 3.1. Data Sources and Construction
- Appendix 3.2. Methodological Details
- Appendix 3.3. Analysis on Dynamic Betas Derived from the Employment Version of Okun’s Law
- Appendix 3.4. Regression Results Using Employment Forecast Errors and a Static Okun’s Law Specification
- Appendix 3.5. Vector Autoregression Forecasting Methodology
- Chapter 4. Getting the Balance Right: Transitioning out of Sustained Current Account Surpluses
- Surplus Reversals: Definition and Anatomy
- Are Policy-Driven Surplus Reversals Detrimental to Growth?
- Surplus Reversals: Case Studies
- Lessons for Economies Considering a Transition out of External Surpluses
- Appendix 4.1. Sample for Analysis and Data Sources
- Appendix 4.2. Scoring Method Used to Group Economies
- Annex: IMF Executive Board Discussion of the Outlook, April 2010
- Statistical Appendix
- What’s New
- Data and Conventions
- Classification of Countries
- General Features and Composition of Groups in the World Economic Outlook Classification
- List of Tables
- World Economic Outlook, Selected Topics
- Box 1.1. Lessons from the Crisis: On the Choice of Exchange Rate Regime
- Box 1.2. How Unusual Is the Current Commodity Price Recovery?
- Box 1.3. Commodity Futures Price Curves and Cyclical Market Adjustment
- Box 3.1. The Dualism between Temporary and Permanent Contracts: Measures, Effects, and Policy Issues
- Box 3.2. Short-Time Work Programs
- Box 4.1. Japan after the Plaza Accord
- Box 4.2. Taiwan Province of China in the Late 1980s
- A1. Economic Policy Assumptions Underlying the Projections for Selected Economies
- Table 1.1. Overview of the World Economic Outlook Projections
- Table 1.2. Commodity Real Price Developments
- Table 1.3. Global Oil Demand and Production by Region
- Table 2.1. Selected Advanced Economies: Real GDP, Consumer Prices, and Current Account Balance
- Table 2.2. Advanced Economies: Unemployment
- Table 2.3. Selected Asian Economies: Real GDP, Consumer Prices, and Current Account Balance
- Table 2.4. Selected European Economies: Real GDP, Consumer Prices, and Current Account Balance
- Table 2.5. Commonwealth of Independent States: Real GDP, Consumer Prices, and Current Account Balance
- Table 2.6. Selected Western Hemisphere Economies: Real GDP, Consumer Prices, and Current Account Balance
- Table 2.7. Selected Middle East and North African Economies: Real GDP, Consumer Prices, and Current Account Balance
- Table 2.8. Selected Sub-Saharan African Economies: Real GDP, Consumer Prices, and Current Account Balance
- Table 3.1. Factors Influencing the Responsiveness of Changes in Unemployment to Changes in Output
- Table 3.2. Unemployment Forecast Errors during Recessions
- Table 3.3. Unemployment Forecast Errors during Recoveries
- Table 3.4. Data Sources
- Table 3.5. Okun’s Law Lag Lengths (Great Recession)
- Table 3.6. Factors Influencing the Responsiveness of Changes in Employment to Changes in Output
- Table 3.7. Employment Forecast Errors during Recessions
- Table 3.8. Employment Forecast Errors during Recoveries
- Table 3.9. Regressions Using Forecast Errors Based on the Static Version of Okun’s Law
- Table 4.1. Decomposition of Current Account Surplus Reversals
- Table 4.2. Exchange Rate Developments during Current Account Surplus Reversals
- Table 4.3. Structural Reallocation during Current Account Surplus Reversals
- Table 4.4. Estimation Results: Change in Growth after Current Account Surplus Reversals
- Table 4.5. Historical Current Account Surplus Reversal Episodes: Relevance for Today’s Current Account Surplus Economies
- Table 4.6. Case Studies: Policies Used during Current Account Surplus Reversals
- Table 4.7. Case Studies: Key Indicators after Current Account Surplus Reversals
- Table 4.8. Sample for Analysis and Current Surplus Episodes
- Table 4.9. Data Sources
- Figure 1.1. Current and Forward-Looking Indicators
- Figure 1.2. Global Indicators
- Figure 1.3. Developments in Mature Credit Markets
- Figure 1.4. Emerging Market Conditions
- Figure 1.5. External Developments
- Figure 1.6. Global Imbalances
- Figure 1.7. General Government Fiscal Balances and Public Debt
- Figure 1.8. Measures of Monetary Policy and Liquidity in Selected Advanced Economies
- Figure 1.9. Prospects for Near-Term Activity
- Figure 1.10. Emerging Economies: GDP Growth by Recession Episode
- Figure 1.11. Global Outlook
- Figure 1.12. Global Inflation
- Figure 1.13. Inflation, Deflation Risk, and Unemployment
- Figure 1.14. Risks to the Global Outlook
- Figure 1.15. Downside Scenario: A Loss of Momentum
- Figure 1.16. Medium-Term Growth Prospects and Precrisis Currency Valuations
- Figure 1.17a. Fiscal Consolidation Packages Designed to Raise Potential Output Different Assumptions about Credibility
- Figure 1.17b. Scenarios Designed to Raise Potential Output and Reduce Government Deficits
- Figure 1.18. Commodity and Petroleum Prices
- Figure 1.19. World Energy Market Developments
- Figure 1.20. Developments in Metal Markets
- Figure 1.21. Recent Developments in Markets for Major Food Crops
- Figure 2.1. Average Projected Real GDP Growth during 2010–11
- Figure 2.2. Decomposing the Variation in 2010–11 Growth Projections
- Figure 2.3. United States: A Stimulus-Supported Recovery
- Figure 2.4. Asia: Average Projected Real GDP Growth during 2010–11
- Figure 2.5. Asia: A Vigorous and Balanced Rebound
- Figure 2.6. Europe: Average Projected Real GDP Growth during 2010–11
- Figure 2.7. Europe: A Moderate Recovery Held Back by Fiscal and External Imbalances
- Figure 2.8. Commonwealth of Independent States: Average Projected Real GDP Growth during 2010–11
- Figure 2.9. Commonwealth of Independent States: A Modest Recovery Ahead
- Figure 2.10. Latin America and the Caribbean: Average Projected Real GDP Growth during 2010–11
- Figure 2.11. Latin America and the Caribbean: A Robust Recovery
- Figure 2.12. Middle East and North Africa: Average Projected Real GDP Growth during 2010–11
- Figure 2.13. Middle East and North Africa: Growing out of Its Downturn
- Figure 2.14. Sub-Saharan Africa: Average Projected Real GDP Growth during 2010–11
- Figure 2.15. Sub-Saharan Africa: Rebounding Strongly
- Figure 3.1. Change in Unemployment Rates and Output Declines during the Great Recession
- Figure 3.2. Broad Measures of Unemployment
- Figure 3.3. Evolution of Employment, Unemployment, and Labor Participation
- Figure 3.4. Labor Dynamics in the United States, Germany, and Japan
- Figure 3.5. Relationship between Unemployment and Output over Time
- Figure 3.6. Output per Capita and Employment Rate Responses during Past Recessions
- Figure 3.7. Dynamic Betas: The Long-Term Impact of Output Fluctuations on Unemployment Rate Dynamics
- Figure 3.8. Decomposition of the Actual Change in the Unemployment Rate during the Great Recession
- Figure 3.9. Decomposition of the Cumulative Change in the Unemployment Rate during the Great Recession
- Figure 3.10. How Long before Employment Recovers?
- Figure 3.11. Forecasts of Employment, Unemployment Rate, and GDP for Advanced Economies, Based on Okun’s Law
- Figure 3.12. Dispersion of GDP Consensus Forecasts
- Figure 3.13. Forecasts of Employment, Unemployment Rate, and GDP for Advanced Economies, Based on Vector Autoregression
- Figure 4.1. Global Imbalances
- Figure 4.2. Methodology Example (Korea 1989)
- Figure 4.3. Output and Employment Growth during Surplus Reversals
- Figure 4.4. Change in Growth after Surplus Reversals
- Figure 4.5. Contributions to Growth
- Figure 4.6. Case Studies: Pretransition Initial Conditions
- Figure 4.7. Case Studies: Posttransition Implications
- Figure 4.8. Japan at the End of Bretton Woods
Assumptions and Conventions
A number of assumptions have been adopted for the projections presented in the World Economic Outlook. It has been assumed that real effective exchange rates remained constant at their average levels during February 23–March 23, 2010, except for the currencies participating in the European exchange rate mechanism II (ERM II), which are assumed to have remained constant in nominal terms relative to the euro; that established policies of national authorities will be maintained (for specific assumptions about fiscal and monetary policies for selected economies, see Box A1); that the average price of oil will be $80.00 a barrel in 2010 and $83.00 a barrel in 2011 and will remain unchanged in real terms over the medium term; that the six-month London interbank offered rate (LIBOR) on U.S. dollar deposits will average 0.5 percent in 2010 and 1.7 percent in 2011; that the three-month euro deposit rate will average 0.9 percent in 2010 and 1.6 percent in 2011; and that the six-month Japanese yen deposit rate will yield on average 0.6 percent in 2010 and 0.7 percent in 2011. These are, of course, working hypotheses rather than forecasts, and the uncertainties surrounding them add to the margin of error that would in any event be involved in the projections. The estimates and projections are based on statistical information available through mid-April 2010.
The following conventions are used throughout the World Economic Outlook:
- … to indicate that data are not available or not applicable;
- –between years or months (for example, 2008–09 or January–June) to indicate the years or months covered, including the beginning and ending years or months;
- / between years or months (for example, 2008/09) to indicate a fiscal or financial year.
- “Billion” means a thousand million; “trillion” means a thousand billion.
- “Basis points” refer to hundredths of 1 percentage point (for example, 25 basis points are equivalent to ¼ of 1 percentage point).
- In figures and tables, shaded areas indicate IMF staff projections.
- If no source is listed on tables and figures, data are drawn from the World Economic Outlook (WEO) database.
- When countries are not listed alphabetically, they are ordered on the basis of economic size.
- Minor discrepancies between sums of constituent figures and totals shown reflect rounding.
As used in this report, the terms “country” and “economy” do not in all cases refer to a territorial entity that is a state as understood by international law and practice. As used here, the term also covers some territorial entities that are not states but for which statistical data are maintained on a separate and independent basis.
The boundaries, colors, denominations, and any other information shown on the maps do not imply, on the part of the International Monetary Fund, any judgment on the legal status of any territory or any endorsement or acceptance of such boundaries.
Further Information and Data
This version of the World Economic Outlook is available in full on the IMF’s website, http://www.imf.org. Accompanying it on the website is a larger compilation of data from the WEO database than is included in the report itself, including files containing the series most frequently requested by readers. These files may be downloaded for use in a variety of software packages.
Inquiries about the content of the World Economic Outlook and the WEO database should be sent by mail, forum, or fax (telephone inquiries cannot be accepted) to
World Economic Studies Division
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Washington, D.C. 20431, U.S.A.
Forum address: www.imf.org/weoforum Fax: (202) 623-6343
The analysis and projections contained in the World Economic Outlook are integral elements of the IMF’s surveillance of economic developments and policies in its member countries, of developments in international financial markets, and of the global economic system. The survey of prospects and policies is the product of a comprehensive interdepartmental review of world economic developments, which draws primarily on information the IMF staff gathers through its consultations with member countries. These consultations are carried out in particular by the IMF’s area departments—namely, the African Department, Asia and Pacific Department, European Department, Middle East and Central Asia Department, and Western Hemisphere Department—together with the Strategy, Policy, and Review Department; the Monetary and Capital Markets Department; and the Fiscal Affairs Department.
The analysis in this report was coordinated in the Research Department under the general direction of Olivier Blanchard, Economic Counsellor and Director of Research. The project was directed by Jörg Decressin, Assistant Director, Research Department, and Petya Koeva Brooks, Division Chief, Research Department.
The primary contributors to this report are Abdul Abiad, Ravi Balakrishnan, Mitali Das, Prakash Kannan, Daniel Leigh, and Marco Terrones. Toh Kuan, Gavin Asdorian, Stephanie Denis, Angela Espiritu, Murad Omoev, Andy Salazar, Min Kyu Song, Ercument Tulun, and Jessie Yang provided research assistance. Saurabh Gupta, Mahnaz Hemmati, Laurent Meister, Emory Oakes, Liessel Ampie, Vladimir Bougay, Anastasia Francis, Wendy Mak, Shamiso Mapondera, Nhu Nguyen, and Steve Zhang managed the database and the computer systems. Jemille Colon, Tita Gunio, Patricia Medina, and Sheila Tomilloso Igcasenza were responsible for word processing. Other contributors include Nese Erbil, Roberto Garcia-Saltos, Thomas Helbling, Doug Laxton, Petar Manchev, Troy Matheson, Dirk Muir, Susanna Mursula, Shaun Roache, Petia Topalova, Charalambos Tsangarides, and Marina Rousset. David Romer of the Research Department provided advice and encouragement. Tito Boeri and Christopher Meissner were external consultants. Kevin Clinton provided comments and suggestions. Linda Griffin Kean of the External Relations Department edited the manuscript and coordinated the production of the publication.
The analysis has benefited from comments and suggestions by staff from other IMF departments, as well as by Executive Directors following their discussion of the report on April 7, 2010. However, both projections and policy considerations are those of the IMF staff and should not be attributed to Executive Directors or to their national authorities.
Joint Foreword to World Economic Outlook and Global Financial Stability Report
The global recovery is proceeding better than expected but at varying speeds—tep-idly in many advanced economies and solidly in most emerging and developing economies. World growth is now expected to be 4¼ percent. Among the advanced economies, the United States is off to a better start than Europe and Japan. Among emerging and developing economies, emerging Asia is leading the recovery, while many emerging European and some Commonwealth of Independent States economies are lagging behind. This multispeed recovery is expected to continue.
As the recovery has gained traction, risks to global financial stability have eased, but stability is not yet assured. Our estimates of banking system write-downs in the economies hit hardest from the onset of the crisis through 2010 have been reduced to $2.3 trillion from $2.8 trillion in the October 2009 Global Financial Stability Report. However, the aggregate picture masks considerable differentiation within segments of banking systems, and there remain pockets that are characterized by shortages of capital, high risks of further asset deterioration, and chronically weak profitability. Deleveraging has so far been driven mainly by deteriorating assets that have hit both earnings and capital. Going forward, however, pressures on the funding or liability side of bank balance sheets are likely to play a greater role, as banks reduce leverage and raise capital and liquidity buffers. Hence, the recovery of private sector credit is likely to be subdued, especially in advanced economies.
At the same time, better growth prospects in many emerging economies and low interest rates in major economies have triggered a welcome resurgence of capital flows to some emerging economies. These capital flows however come with the attendant risk of inflation pressure and asset bubbles. So far, there is no systemwide evidence of bubbles, although there are a few hot spots, and risks could build up over a longer-term horizon. The recovery of cross-border financial flows has brought some real effective exchange rate changes—depreciation of the U.S. dollar and appreciation of other floating currencies of advanced and emerging economies. But these changes have been limited, and global current account imbalances are forecast to widen once again.
The outlook for activity remains unusually uncertain, and downside risks stemming from fiscal fragilities have come to the fore. A key concern is that room for policy maneuvers in many advanced economies has either been exhausted or become much more limited. Moreover, sovereign risks in advanced economies could undermine financial stability gains and extend the crisis. The rapid increase in public debt and deterioration of fiscal balance sheets could be transmitted back to banking systems or across borders.
This underscores the need for policy action to sustain the recovery of the global economy and financial system. The policy agenda should include several important elements.
The key task ahead is to reduce sovereign vulnerabilities. In many advanced economies, there is a pressing need to design and communicate credible medium-term fiscal consolidation strategies. These should include clear time frames to bring down gross debt-to-GDP ratios over the medium term as well as contingency measures if the deterioration in public finances is greater than expected. If macroeconomic developments proceed as expected, most advanced economies should embark on fiscal consolidation in 2011. Meanwhile, given the still-fragile recovery, the fiscal stimulus planned for 2010 should be fully implemented, except in economies that face large increases in risk premiums, where the urgency is greater and consolidation needs to begin now. Entitlement reforms that do not detract from demand in the short term—for example, raising the statutory retirement age or lowering the cost of health care—should be implemented without delay.
Other policy challenges relate to unwinding monetary accommodation across the globe and managing capital flows to emerging economies. In major advanced economies, insofar as inflation expectations remain well anchored, monetary policy can continue being accommodative as fiscal consolidation progresses, even as central banks begin to withdraw the emergency support provided to financial sectors. Major emerging and some advanced economies will continue to lead the tightening cycle, since they are experiencing faster recoveries and renewed capital flows. Although there is only limited evidence of inflation pressures and asset price bubbles, current conditions warrant close scrutiny and early action. In emerging economies with relatively balanced external positions, the defense against excessive currency appreciation should include a combination of macroeconomic and prudential policies, which are discussed in detail in the World Economic Outlook and Global Financial Stability Report.
Combating unemployment is yet another policy challenge. As high unemployment persists in advanced economies, a major concern is that temporary joblessness will turn into long-term unemployment. Beyond pursuing macroeconomic policies that support recovery in the near term and financial sector policies that restore banking sector health (and credit supply to employment-intensive sectors), specific labor market policies could also help limit damage to the labor market. In particular, adequate unemployment benefits are essential to support confidence among households and to avoid large increases in poverty, and education and training can help reintegrate the unemployed into the labor force.
Policies also need to buttress lasting financial stability, so that the next stage of the deleveraging process unfolds smoothly and results in a safer, competitive, and vital financial system. Swift resolution of nonviable institutions and restructuring of those with a commercial future is key. Care will be needed to ensure that too-important-to-fail institutions in all jurisdictions do not use the funding advantages their systemic importance gives them to consolidate their positions even further. Starting securitization on a safer basis is also essential to support credit, particularly for households and small and medium-size enterprises.
Looking further ahead, there must be agreement on the regulatory reform agenda. The direction of reform is clear—higher quantity and quality of capital and better liquidity risk management—but the magnitude is not. In addition, uncertainty surrounding reforms to address too-important-to-fail institutions and systemic risks make it difficult for financial institutions to plan. Policymakers must strike the right balance between promoting the safety of the financial system and keeping it innovative and efficient. Specific proposals for making the financial system safer and for strengthening its infrastructure—for example, in the over-the-counter derivatives market—are discussed in the Global Financial Stability Report.
Finally, the world’s ability to sustain high growth over the medium term depends on rebalancing global demand. This means that economies that had excessive external deficits before the crisis need to consolidate their public finances in ways that limit damage to growth and demand. Concurrently, economies that ran excessive current account surpluses will need to further increase domestic demand to sustain growth, as excessive deficit economies scale back their demand. As the currencies of economies with excessive deficits depreciate, those of surplus economies must logically appreciate. Rebalancing also needs to be supported with financial sector reform and growth-enhancing structural policies in both surplus and deficit economies.
In 2010, world output is expected to rise by about 4¼ percent, following a ½ percent contraction in 2009. Economies that are off to a strong start are likely to remain in the lead, as growth in others is held back by lasting damage to financial sectors and household balance sheets. Activity remains dependent on highly accommodative macroeconomic policies and is subject to downside risks, as fiscal fragilities have come to the fore. In most advanced economies, fiscal and monetary policies should maintain a supportive thrust in 2010 to sustain growth and employment. But many of these economies also need to urgently adopt credible medium-term strategies to contain public debt and later bring it down to more prudent levels. Financial sector repair and reform are additional high-priority requirements. Many emerging economies are again growing rapidly and a number have begun to moderate their accommodative macroeconomic policies in the face of high capital inflows. Given prospects for relatively weak growth in the advanced economies, the challenge for emerging economies is to absorb rising inflows and nurture domestic demand without triggering a new boom-bust cycle.
Recovery Has Proceeded Better than Expected
The global recovery has evolved better than expected, with activity recovering at varying speeds—tepidly in many advanced economies but solidly in most emerging and developing economies. Policy support was essential to jump-start the recovery. Monetary policy has been highly expansionary and supported by unconventional liquidity provision. Fiscal policy provided a major stimulus in response to the deep downturn. Among advanced economies, the United States is off to a better start than Europe and Japan. Among emerging and developing economies, emerging Asia is in the lead. Growth is also solidifying in key Latin American and other emerging and developing economies but continues to lag in many emerging European and various Commonwealth of Independent States (CIS) countries. Sub-Saharan Africa is weathering the global crisis well, and its recovery is expected to be stronger than following past global downturns.
The recoveries in real and financial activity are mutually supportive, but access to credit remains difficult for some sectors. Money markets have stabilized. Corporate bond and equity markets have rebounded. In advanced economies, the tightening of bank lending standards is ending, and the credit crisis appears to be bottoming out. In many emerging and developing economies, credit growth is reaccelerating. Nevertheless, financial conditions remain more difficult than before the crisis. Especially in advanced economies, bank capital is likely to remain a constraint on growth as banks continue to retrench their balance sheets. Sectors that have only limited access to capital markets—consumers and small and medium-size enterprises—are likely to continue to face tight limits on their borrowing. In a few advanced economies, rising public deficits and debt have contributed to a sharp increase in sovereign risk premiums, posing new risks to the recovery.
Together with real and financial activity, cross-border financial flows from advanced to many emerging economies have also rebounded strongly. Key drivers include rapid growth in emerging economies, large yield differentials in their favor, and a returning appetite for risk. The recovery of cross-border flows has come with some real effective exchange rate changes—depreciation of the U.S. dollar and appreciation of some other floating currencies of advanced and emerging economies. But relative to precrisis levels, changes have been generally limited, and global current account imbalances are forecast to widen again over the medium term.
Multispeed Recovery Will Continue
The world economy is poised for further recovery but at varying speeds across and within regions. Global growth is projected to reach 4¼ percent in 2010 and 2011. Advanced economies are now expected to expand by 2¼ percent in 2010, and by 2½ percent in 2011, following a decline in output of more than 3 percent in 2009. Growth in emerging and developing economies is projected to be over 6¼ percent during 2010–11, following a modest 2½ percent in 2009. As Chapters 1 and 2 explain, economies that are off to a strong start are likely to continue to lead the recovery, as growth in others is held back by lasting damage to financial sectors and household balance sheets. The recovery under way in the major advanced economies will be relatively sluggish compared with recoveries from previous recessions. Likewise, the recoveries in many economies of emerging Europe and the CIS are likely to be sluggish compared with those expected for many other emerging economies.
The outlook for activity remains unusually uncertain, even though a variety of risks have receded. Risks are generally to the downside, with those related to public debt growth in advanced economies having become sharply more evident. In the near term, a risk is that, if unchecked, market concerns about sovereign liquidity and solvency in Greece could turn into a full-blown and contagious sovereign debt crisis, as explained in the April 2010 Global Financial Stability Report (GFSR). More generally, the main concern is that room for policy maneuver in many advanced economies has either been largely exhausted or is much more limited, leaving the fragile recoveries exposed to new shocks. In addition, bank exposures to real estate continue to pose downside risks, mainly in the United States and parts of Europe.
Policies Need to Sustain and Strengthen Recovery
Given the large amount of public debt that has been accumulated during this recession, in many advanced economies exit policies need to emphasize fiscal consolidation and financial sector repair. This will allow monetary policy to remain accommodative without leading to inflation pressure or financial market instabilities. In emerging and developing economies, priorities depend on room available for fiscal policy maneuvers and on current account positions. Spillovers related to fiscal policies are particularly relevant for the major advanced economies, as large deficits and the lack of well-specified medium-term fiscal consolidation strategies in these economies could adversely affect funding costs of other advanced or emerging economies.
Medium-Term Fiscal Consolidation Strategies Are Urgently Needed
Fiscal policy provided major support in response to the deep downturn. At the same time, the slump in activity and, to a much lesser extent, stimulus measures pushed fiscal deficits in advanced economies to about 9 percent of GDP. Debt-to-GDP ratios in these economies are expected to exceed 100 percent of GDP in 2014 based on current policies, some 35 percentage points of GDP higher than before the crisis.
Regarding the near term, given the fragile recovery, fiscal stimulus planned for 2010 should be fully implemented, except in countries that are suffering large increases in risk premiums—these countries need to begin fiscal consolidation now. Looking further ahead, if macroeconomic developments proceed as expected, most advanced economies should embark on significant fiscal consolidation in 2011. Countries urgently need to design and implement credible fiscal adjustment strategies, emphasizing measures that support potential growth. These should include clear timelines to bring down gross debt-to-GDP ratios over the medium term. Also needed are reforms to entitlement spending that lower spending in the future but do not depress demand today.
The fiscal challenges are different in a number of emerging economies, with some important exceptions. The public debt problem in these economies is more localized—as a group, these economies’ public debt ratios are at about 30 to 40 percent of GDP and, given their high growth, are expected to soon be back on a declining path. Many emerging Asian economies entered the crisis with relatively low public debt levels and can afford to maintain an expansionary fiscal stance. This will help rebalance the mix between externally and domestically driven growth. But these economies will need to be alert to growing price pressures and emerging financial instability and to allow their currencies to appreciate to combat overheating. Other major emerging economies, however, have less fiscal room to maneuver and should withdraw support as the recovery gains more traction. Fiscal policy in low-income economies will also need to be redirected toward medium-term considerations as private and external demand recovers.
Monetary Accommodation Needs to Be Unwound Cautiously and Capital Inflows Managed
Still-low levels of capacity utilization and well-anchored inflation expectations are expected to keep inflation in check in most economies. Significant upside risks to inflation are confined to emerging economies that have a history of unstable price levels or have limited economic slack. In major advanced economies, monetary policy can remain accommodative as fiscal consolidation progresses, provided inflation pressure remains subdued. This can be achieved even as central banks begin to withdraw the emergency support provided to financial sectors. In major emerging and some advanced economies that are experiencing faster recoveries, central banks have already begun to reduce the degree of monetary accommodation or are expected by the markets to do so over the coming year. These economies will probably continue to lead the tightening cycle, as they are expected to recover faster than major advanced economies. In some emerging economies, overcapacity in some sectors and deteriorating credit quality also point to the need to tighten credit.
In emerging economies with excessive surpluses, monetary tightening should be supported with nominal effective exchange rate appreciation as excess demand pressures build, including in response to continued fiscal support to facilitate demand rebalancing or capital inflows. In others, monetary tightening may be complicated: it could attract more capital inflows, lead to exchange rate appreciation, and thereby undermine competitiveness. If exchange rate overshooting becomes a concern, countries should consider fiscal tightening to ease pressure on interest rates; some buildup of reserves; and possibly stricter controls on capital inflows—mindful of the potential to create new distortions—or looser controls on outflows.
Financial Sectors Must Be Repaired and Reformed
Together with fiscal adjustment, more progress with financial sector repair and reform is the top priority for a number of advanced economies to sustain recovery. Moreover, financial market inefficiencies and regulatory and supervisory failures played a major role in the crisis and need to be remedied to build a stronger financial system. For advanced economies, the April 2010 GFSR has lowered its estimate of actual and prospective bank write-downs and loan loss provisions during 2007–10 from $2.8 trillion to $2.3 trillion, two-thirds of which had been recognized by the end of 2009. Progress in remedying financial inefficiencies and reforming prudential policies and frameworks will increase the effectiveness of monetary policy and reduce the risk of the ample supply of liquidity finding an outlet in renewed speculative distortions. At the same time, emerging economies will need to continue to strengthen their prudential policies and frameworks in anticipation of growing capital inflows.
Policies to Support the Unemployed and Foster Employment Are Essential
High unemployment poses major social problems. In advanced economies, unemployment is projected to stay close to 9 percent through 2011 and then to decline only slowly. Chapter 3 explains that unemployment responses have been markedly different across advanced economies because of differences in output declines, labor market institutions, and factors such as financial stress and house price busts. Moreover, in many countries problems are larger than the headline unemployment rate statistics suggest because many individuals are underemployed or have dropped out of the labor force. In this setting, a major concern is the potential for temporary joblessness to turn into long-term unemployment and to lower potential output growth. To limit damage to the labor market, macroeconomic policies need to be appropriately supportive of the recovery where possible. At the same time, policies need to foster wage flexibility and provide adequate support for the jobless.
Rebalancing Global Demand Is Key to Buoy and Sustain Growth
For the world economy to sustain a high-growth trajectory, the economies that had excessive external deficits before the crisis need to consolidate their public finances in ways that limit damage to potential growth and demand. Concurrently, economies that ran excessive current account surpluses will need to further increase domestic demand to sustain growth, as excessive-deficit economies scale back their demand (and imports) in response to lower expectations about future income. As the currencies of economies with excessive deficits depreciate, then logically those of surplus economies must appreciate. Rebalancing needs to be supported with financial sector reform and structural policies in both surplus and deficit economies. Policymakers will need to exploit policy synergies, especially between fiscal policy and structural reform.
Global demand rebalancing is not a new issue. Chapter 4 reviews the historical experience of economies with large current account surpluses. It finds that reversing current account surpluses has typically not been associated with losses in economic growth, with a variety of macroeconomic and structural policies playing an important role in countering output losses from real exchange rate appreciation.