The world economic recovery continues, but it has weakened further. In advanced countries, growth is now too low to make a substantial dent in unemployment. And in major emerging countries, growth that had been strong earlier has also decreased.
Relative to the IMF’s forecasts last April, our 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. They are however stronger for two sets of countries–for the members of the euro area, where we now expect growth close to zero in 2013, and for three of the large emerging market economies, China, India, and Brazil.
The forces at work are for the most part familiar. Let me start with the advanced economies.
The main force pulling up growth is accommodative monetary policy. Central banks continue not only to maintain very low policy rates, but also to experiment with programs aimed at decreasing rates in particular markets, at helping particular categories of borrowers, or at helping financial intermediation in general.
But two forces continue to pull growth down—fiscal consolidation, and a still weak financial system.
In most countries, fiscal consolidation is proceeding according to plan. While this consolidation is needed, there is no question that it is weighing on demand, and the evidence increasingly suggests that, in the current environment, the fiscal multipliers are large—larger than in normal times.
The financial system is still not functioning efficiently. In many countries, more so in Europe than in the United States, banks are still weak, and their position is made worse by low growth. As a result, many borrowers still face tight borrowing conditions.
And more seems to be at work than these mechanical forces, call it a general feeling of uncertainty about the future. Worries about the ability of European policymakers to control the euro crisis, worries about the failure of U.S. policymakers to agree so far on a fiscal plan, worries about the ability of Japanese policymakers to reduce their budget deficit further–all appear to play an important role, although one which is hard to nail down.
Let me turn to emerging market and developing economies.
A constant theme of our IMF forecasts has been the degree to which the world economy is interconnected, be it through trade or through capital flows. And this time is no exception.
Low growth in advanced countries is affecting emerging and developing economies through exports. As was the case in 2009, trade channels are surprisingly strong, with, for example, lower exports accounting for most of the decrease in growth in China, and through supply chains, much of the decrease in growth in Asia.
Alternative risk-off and risk-on episodes, triggered by progress and regress on policy actions, are triggering volatile capital flows, in particular to Asia and to Latin America.
Adding to these are some home grown woes, policy uncertainty in India affecting domestic demand, tighter policies in Brazil in response to an earlier boom.
We do not see these developments as signs of a hard landing in any of these countries. Indeed, we see positive policy measures being taken in all three countries. But they suggest lower growth for some time, lower than we have seen in the recent past.
What should be done?
The general strategy is clear. Continue with accommodating monetary policy, which is a very powerful force for growth, and limit the adverse effects of the brakes holding things back. Continue with steady fiscal consolidation; our advice still holds: not too slow, not too fast. Continue to repair the financial system. Decrease policy uncertainty. In other words, deliver fiscal consolidation and maintain growth.
In the short run however, the main issue continues the state of the euro area, and this is what I shall concentrate my remaining remarks on.
Over the past few months, it is clear that there has been an important change in attitudes in the euro area, and the realization that an ambitious architecture must be put in place.
The lessons of the past few years are now clear: euro area countries can be hit by strong shocks. Weak banks can considerably amplify the adverse effects of these shocks. And, if it looks like the sovereign itself might be in trouble, sovereign/bank interactions can further worsen the outcome.
Thus a new architecture must aim at reducing the amplitude of the shocks in the first place; at putting in place a system of transfers to soften the effects of the shocks. It must aim at moving the supervision, the resolution, the recapitalization process of banks to the euro level.
It is good to see these issues being seriously explored, and some of these mechanisms being put together. In the short term however, more immediate measures are needed.
Spain and Italy must follow through with adjustment plans which reestablish competitiveness and fiscal balance, and maintain growth. To do so, they must be able to recapitalize their banks, if needed, without adding to their sovereign debt. And they must be able to borrow at reasonable rates. Most of these pieces are in the process of falling into in place, and if the complex puzzle can be rapidly completed, one can reasonably hope that the worst might be behind us.
If uncertainty is indeed partly behind the current slowdown, and if the adoption and implementation of these measures decrease it, things may turn out better than our forecasts, not only in Europe, but also in the rest of the world. The case for an upside scenario is a bit stronger than it has been for a while.
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