Russian
World
Economic Outlook Update
Global Recovery Advances but Remains
Uneven
January 25,
2011
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The two-speed recovery continues. In advanced economies,
activity has moderated less than expected, but growth remains
subdued, unemployment is still high, and renewed stresses in the
euro area periphery are contributing to downside risks. In many
emerging economies, activity remains buoyant, inflation
pressures are emerging, and there are now some signs of
overheating, driven in part by strong capital inflows. Most
developing countries, particularly in sub-Saharan Africa, are
also growing strongly. Global output is projected to expand by
4½ percent in 2011 ( Table
1 and
Figure 1:
CSV| PDF) ,
an upward revision of about ¼ percentage point relative to the
October 2010 World Economic Outlook (WEO). This reflects
stronger-than-expected activity in the second half of 2010 as
well as new policy initiatives in the United States that will
boost activity this year. But downside risks to the recovery
remain elevated. The most urgent requirements for robust
recovery are comprehensive and rapid actions to overcome
sovereign and financial troubles in the euro area and policies
to redress fiscal imbalances and to repair and reform financial
systems in advanced economies more generally. These need to be
complemented with policies that keep overheating pressures in
check and facilitate external rebalancing in key emerging
economies.The global recovery is proceeding
Global activity expanded at an annualized rate of just over
3½ percent in the third quarter of 2010. A slowdown from the 5
percent growth rate of the second quarter of 2010 was expected,
but the third-quarter rate was better than forecast in the
October 2010 WEO, owing to stronger-than-expected consumption in
the United States and Japan. Stimulus measures were partly
responsible for the strengthened outturn, especially in Japan.
More generally, signs are increasing that private consumption—which
fell sharply during the crisis—is starting to gain a foothold in
major advanced economies (Figure
2:
CSV|PDF).
Growth in emerging and developing economies remained robust in
the third quarter, buoyed by well-entrenched private demand,
still-accommodative policy stances, and resurgent capital
inflows.
During the second half of 2010, global financial conditions
broadly improved, amid lingering vulnerabilities. Equity markets
rose, risk spreads continued to tighten, and bank lending
conditions in major advanced economies became less tight, even
for small and medium-sized firms. Nonetheless, pockets of
vulnerability persisted; real estate markets and household
income were still weak in some major advanced economies (for
example, United States), and securitization remained subdued.
And, in an echo of last May’s events, financial turbulence
reemerged in the periphery of the euro area in the last quarter
of 2010. Concerns about banking sector losses and fiscal
sustainability—triggered this time by the situation in Ireland—led
to widening spreads in these countries, in some cases reaching
highs not seen since the launch of the European Economic and
Monetary Union. Funding pressures also reappeared, although to a
lesser extent than during the summer. One key difference was
more limited financial market spillovers to other countries. The
turmoil in mid-2010 led to a spike in global risk aversion and a
scaling back of exposures in other regions, including emerging
markets. During the recent bout of turbulence, markets have been
more discriminating: measures of risk aversion have not risen,
equity markets in most regions have posted significant gains,
and financial stresses have been limited mostly to the periphery
of the euro area (Figure
3:
CSV|PDF).
|
Table 1. Overview of the World Economic Outlook
Projections
(Percent change, unless otherwise noted)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Year over Year |
|
|
|
|
|
|
|
|
|
|
Difference from October 2010 WEO
Projections |
|
Q4 over Q4 |
|
|
|
Projections |
|
|
Estimates |
Projections |
|
2009 |
2010 |
2011 |
2012 |
|
2011 |
2012 |
|
2010 |
2011 |
2012 |
|
World Output 1 |
–0.6 |
5.0 |
4.4 |
4.5 |
|
0.2 |
0.0 |
|
4.7 |
4.5 |
4.4 |
Advanced Economies |
–3.4 |
3.0 |
2.5 |
2.5 |
|
0.3 |
–0.1 |
|
2.9 |
2.6 |
2.5 |
United
States |
–2.6 |
2.8 |
3.0 |
2.7 |
|
0.7 |
–0.3 |
|
2.7 |
3.2 |
2.7 |
Euro
Area |
–4.1 |
1.8 |
1.5 |
1.7 |
|
0.0 |
–0.1 |
|
2.1 |
1.2 |
2.0 |
Germany |
–4.7 |
3.6 |
2.2 |
2.0 |
|
0.2 |
0.0 |
|
4.3 |
1.2 |
2.7 |
France |
–2.5 |
1.6 |
1.6 |
1.8 |
|
0.0 |
0.0 |
|
1.7 |
1.5 |
1.9 |
Italy |
–5.0 |
1.0 |
1.0 |
1.3 |
|
0.0 |
–0.1 |
|
1.3 |
1.2 |
1.4 |
Spain |
–3.7 |
–0.2 |
0.6 |
1.5 |
|
–0.1 |
–0.3 |
|
0.4 |
0.8 |
1.9 |
Japan |
–6.3 |
4.3 |
1.6 |
1.8 |
|
0.1 |
–0.2 |
|
3.3 |
1.4 |
2.4 |
United
Kingdom |
–4.9 |
1.7 |
2.0 |
2.3 |
|
0.0 |
0.0 |
|
2.9 |
1.5 |
2.6 |
Canada |
–2.5 |
2.9 |
2.3 |
2.7 |
|
–0.4 |
0.0 |
|
2.7 |
2.7 |
2.6 |
Other
Advanced Economies |
–1.2 |
5.6 |
3.8 |
3.7 |
|
0.1 |
0.0 |
|
4.5 |
4.7 |
2.9 |
Newly Industrialized Asian Economies |
–0.9 |
8.2 |
4.7 |
4.3 |
|
0.2 |
–0.1 |
|
5.9 |
6.2 |
3.1 |
Emerging and Developing Economies
2 |
2.6 |
7.1 |
6.5 |
6.5 |
|
0.1 |
0.0 |
|
7.2 |
7.0 |
6.8 |
Central and Eastern Europe |
–3.6 |
4.2 |
3.6 |
4.0 |
|
0.5 |
0.2 |
|
4.3 |
3.5 |
3.9 |
Commonwealth of Independent States |
–6.5 |
4.2 |
4.7 |
4.6 |
|
0.1 |
–0.1 |
|
3.5 |
4.8 |
4.3 |
Russia |
–7.9 |
3.7 |
4.5 |
4.4 |
|
0.2 |
0.0 |
|
3.4 |
4.6 |
4.3 |
Excluding Russia |
–3.2 |
5.4 |
5.1 |
5.2 |
|
–0.1 |
–0.1 |
|
. . . |
. . . |
. . . |
Developing Asia |
7.0 |
9.3 |
8.4 |
8.4 |
|
0.0 |
0.0 |
|
9.1 |
8.6 |
8.4 |
China |
9.2 |
10.3 |
9.6 |
9.5 |
|
0.0 |
0.0 |
|
9.7 |
9.5 |
9.5 |
India |
5.7 |
9.7 |
8.4 |
8.0 |
|
0.0 |
0.0 |
|
10.3 |
7.9 |
8.0 |
ASEAN-5 3 |
1.7 |
6.7 |
5.5 |
5.7 |
|
0.1 |
0.1 |
|
5.1 |
6.4 |
5.2 |
Latin
America and the Caribbean |
–1.8 |
5.9 |
4.3 |
4.1 |
|
0.3 |
–0.1 |
|
4.8 |
5.0 |
4.3 |
Brazil |
–0.6 |
7.5 |
4.5 |
4.1 |
|
0.4 |
0.0 |
|
5.2 |
5.1 |
4.0 |
Mexico |
–6.1 |
5.2 |
4.2 |
4.8 |
|
0.3 |
–0.2 |
|
3.2 |
5.0 |
4.5 |
Middle
East and North Africa |
1.8 |
3.9 |
4.6 |
4.7 |
|
–0.5 |
–0.1 |
|
. . . |
. . . |
. . . |
Sub-Saharan
Africa |
2.8 |
5.0 |
5.5 |
5.8 |
|
0.0 |
0.1 |
|
. . . |
. . . |
. . . |
South Africa |
–1.7 |
2.8 |
3.4 |
3.8 |
|
–0.1 |
–0.1 |
|
3.6 |
3.4 |
4.1 |
Memorandum |
|
|
|
|
|
|
|
|
|
|
|
European
Union |
–4.1 |
1.8 |
1.7 |
2.0 |
|
0.0 |
–0.1 |
|
2.5 |
1.4 |
2.2 |
World
Growth Based on Market Exchange Rates |
–2.1 |
3.9 |
3.5 |
3.6 |
|
0.2 |
–0.1 |
|
. . . |
. . . |
. . . |
|
|
|
|
|
|
|
|
|
|
|
|
World Trade Volume (goods and services) |
–10.7 |
12.0 |
7.1 |
6.8 |
|
0.1 |
0.2 |
|
. . . |
. . . |
. . . |
Imports |
|
|
|
|
|
|
|
|
|
|
|
Advanced
Economies |
–12.4 |
11.1 |
5.5 |
5.2 |
|
0.3 |
0.1 |
|
. . . |
. . . |
. . . |
Emerging
and Developing Economies |
–8.0 |
13.8 |
9.3 |
9.2 |
|
–0.6 |
–0.1 |
|
. . . |
. . . |
. . . |
Exports |
|
|
|
|
|
|
|
|
|
|
|
Advanced
Economies |
–11.9 |
11.4 |
6.2 |
5.8 |
|
0.2 |
0.3 |
|
. . . |
. . . |
. . . |
Emerging
and Developing Economies |
–7.5 |
12.8 |
9.2 |
8.8 |
|
0.1 |
0.2 |
|
. . . |
. . . |
. . . |
Commodity Prices (U.S. dollars) |
|
|
|
|
|
|
|
|
|
|
|
Oil
4 |
–36.3 |
27.8 |
13.4 |
0.3 |
|
10.1 |
–4.1 |
|
. . . |
. . . |
. . . |
Nonfuel
(average based on world commodity export weights) |
–18.7 |
23.0 |
11.0 |
–5.6 |
|
13.0 |
–2.4 |
|
. . . |
. . . |
. . . |
|
|
|
|
|
|
|
|
|
|
|
|
Consumer Prices |
|
|
|
|
|
|
|
|
|
|
|
Advanced
Economies |
0.1 |
1.5 |
1.6 |
1.6 |
|
0.3 |
0.1 |
|
1.5 |
1.6 |
1.6 |
Emerging
and Developing Economies
2 |
5.2 |
6.3 |
6.0 |
4.8 |
|
0.8 |
0.3 |
|
6.5 |
4.7 |
4.4 |
London Interbank Offered Rate (percent)
5 |
|
|
|
|
|
|
|
|
|
|
|
On U.S.
Dollar Deposits |
1.1 |
0.6 |
0.7 |
0.9 |
|
–0.1 |
–0.5 |
|
. . . |
. . . |
. . . |
On Euro
Deposits |
1.2 |
0.8 |
1.2 |
1.7 |
|
0.2 |
0.4 |
|
. . . |
. . . |
. . . |
On
Japanese Yen Deposits |
0.7 |
0.4 |
0.6 |
0.2 |
|
0.2 |
–0.2 |
|
. . . |
. . . |
. . . |
|
Note: Real effective exchange rates
are assumed to remain constant at the levels
prevailing during November 18–December 16, 2010.
Country weights used to construct aggregate growth
rates for groups of economies were revised. When
economies are not listed alphabetically, they are
ordered on the basis of economic size. The
aggregated quarterly data are seasonally adjusted. |
1 The
quarterly estimates and projections account for 90
percent of the world purchasing-power-parity weights. |
2 The
quarterly estimates and projections account for
approximately 78 percent of the emerging and
developing economies. |
3
Indonesia, Malaysia, Philippines, Thailand, and
Vietnam. |
4 Simple
average of prices of U.K. Brent, Dubai, and West
Texas Intermediate crude oil. The average price of
oil in U.S. dollars a barrel was $78.93 in 2010; the
assumed price based on futures markets is $89.50 in
2011 and $89.75 in 2012. |
5
Six-month rate for the United States and Japan.
Three-month rate for the Euro Area. |
The recovery is set to continue…
The baseline projections below assume that
current policy actions manage to keep the financial turmoil and
its real effects contained in the periphery of the euro area,
resulting in only a modest drag on the global recovery. This
view reflects the limited financial spillovers observed so far
across financial markets and regions, as well as the fact that
policy responses following the Greek crisis helped limit its
impact on the global recovery in the second half of 2010. The
baseline also assumes that policymakers in emerging markets
respond in a timely manner to keep overheating pressures in
check.
Activity in the advanced economies is projected
to expand by 2½ percent during 2011–12, which is still sluggish
considering the depth of the 2009 recession and insufficient to
make a significant dent in high unemployment rates. Nevertheless,
the 2011 growth projection is an upward revision of ¼ percentage
point relative to the October 2010 WEO, mostly due to a new
fiscal package passed in late 2010 in the United States that is
expected to boost economic growth this year by ½ percent. A
package with a similar growth impact passed in Japan is expected
to sustain a moderate recovery in 2011. And although growth in
the periphery of the euro area is marked down for this year,
this is offset by an upward revision to growth in Germany, due
to stronger domestic demand.
In both 2011 and 2012, growth in emerging and
developing economies is expected to remain buoyant at 6½ percent,
a modest slowdown from the 7 percent growth registered last year
and broadly unchanged from the October 2010 WEO. Developing Asia
continues to grow most rapidly, but other emerging regions are
also expected to continue their strong rebound. Notably, growth
in sub-Saharan Africa—projected at 5½ percent in 2011 and 5¾
percent in 2012—is expected to exceed growth in all other
regions except developing Asia. This reflects sustained strength
in domestic demand in many of the region’s economies as well as
rising global demand for commodities (Box
1).
…and financial conditions in most regions are
expected to remain stable
Financial conditions are expected generally to
remain stable or improve this year. Bank lending conditions in
the major advanced economies are expected to ease further, and
bond issuance by nonfinancial firms is also expected to
strengthen. Amid generally sluggish recovery and continued high
saving in key emerging Asian economies, real yields are likely
to remain low through 2011. In the United States, the outlook
for Treasury yields is uncertain: a gradually strengthening
recovery and fiscal concerns may push up yields, while
quantitative easing may hold them back.
Financial stresses, however, are expected to
remain elevated in the periphery of the euro area, where market
participants are still concerned about sovereign and banking
risk, the political feasibility of current and envisioned
austerity measures, and the lack of a comprehensive solution.
European sovereign peripheral spreads and bank funding costs are
thus likely to remain elevated during the first half of this
year, and financial turbulence could re-intensify.
Under a baseline scenario in which contagion
from turmoil in the euro area periphery is contained, emerging
market capital inflows are expected to remain strong and
financial conditions robust. Bond issuance by emerging market
sovereigns and firms is expected to remain robust in 2011. Low
interest rates in mature markets and fairly strong investor
appetite will continue to pose upside risks to emerging market
flows and asset prices, despite some recent slowdown of inflows.
Box 1. Economic Outlook for
Sub-Saharan Africa
Most countries in sub-Saharan
Africa have recovered quickly from the global
financial crisis, with the region projected to grow
5½ percent in 2011. But the pace of the recovery has
varied within the region. Output growth in most oil
exporters and low-income countries (LICs) is now
close to precrisis highs. The recovery in South
Africa and its neighbors, however, has been more
subdued, reflecting the more severe impact of the
collapse in world trade and elevated unemployment
levels that are proving difficult to reduce.
Prior to the recent global crisis,
sub-Saharan Africa enjoyed a period of strong growth.
Growth in the region’s 29 LICs was particularly
impressive at more than 6 percent during 2004–08,
second only to developing Asia. This reflected the
improved political environment, favorable external
conditions, and sound macroeconomic management.
These strong initial conditions helped most
countries in the region weather the worst effects of
the food and fuel price hikes of 2007–08 and the
subsequent global financial crisis. Many countries
supported output by injecting fiscal stimulus and
lowering interest rates. As a result, LICs in the
region continued to grow at nearly 5 percent in
2009, although output fell in the region’s
middle-income countries—a grouping dominated by
South Africa. In most of the oil-exporting countries
growth slowed, with the notable exception of
Nigeria.
Most countries in the region have
now returned to precrisis growth rates. In 2011,
LICs are projected to grow by 6½ percent. Domestic
demand is being supported by automatic stabilizers,
expansion in public investment and social support
programs, and continued monetary accommodation.
Growing trade ties with Asia are also playing a role
in the region’s recovery, primarily through
commodity markets. Output growth has rebounded in
South Africa, but high unemployment and subdued
confidence are expected to continue to dampen the
pace of recovery, restricting growth to about 3½
percent in 2011.
Risks remain weighted to the
downside, however. The pace of recovery in Europe,
the dominant trade partner for most
non-oil-exporting countries in sub-Saharan Africa,
is modest and uncertain. More immediately, the sharp
pickup in fuel and food prices stands to make a
significant impact on many non-oil-exporting
countries. Rising food prices are likely to affect
the urban poor in particular, given the high share
of food in their consumption baskets. In response,
governments will need to consider targeted social
safety nets, with attendant fiscal costs. Managing
these pressures, particularly against the backdrop
of elevated fiscal deficits and narrowing output
gaps, will be an important challenge for the region
in 2011—a year with a busy political calendar,
including perhaps 17 national elections.
With recovery at hand in most
countries in the region, the emphasis of
macroeconomic policies needs to shift:
-
Countercyclical fiscal policy
helped support output growth during the crisis,
but has resulted in wider fiscal deficits across
the board. With growth in most countries now
approaching potential, the consistency of these
wider deficits with financing and medium-term
debt sustainability considerations should be
reviewed. To promote growth and poverty
reduction, attention also needs to be given to
the appropriateness of the composition of
government spending and revenue sources.
-
Inflation remains in check in
most countries, and the monetary stance seems
appropriate. But policymakers should remain
alert to potential pressure from rising
commodity prices—particularly with growth
approaching potential levels.
-
Other policy areas requiring
sustained attention include more intensive
monitoring and sounder regulation of the
financial sector, continuing policy improvements
targeted at the business environment, and robust
public financing mechanisms to plan and control
government spending, including infrastructure
investment.
|
Commodity prices will remain high, and inflation is
rising in some emerging economies
Prices for both oil and non-oil commodities rose
considerably in 2010, in response to strong global demand
but also to supply shocks for selected commodities. Upward
pressure on prices is expected to persist in 2011, due to
continued robust demand and a sluggish supply response to
tightening market conditions. As a result, the IMF’s
baseline petroleum price projection for 2011 is now $90 per
barrel, up from $79 per barrel in the October 2010 WEO. As
for non-oil commodities, weather-related crop damage was
greater than expected in late 2010, and price effects are
expected to unwind only after the 2011 crop season. As a
result, non-oil commodity prices are expected to increase by
11 percent in 2011. Near-term risks are now to the upside
for most commodity classes.
The uptick in consumer price inflation in emerging
economies in 2010 was attributable partly to rising food
prices. But the recent bout of high food price inflation has
been quite persistent, straining the budgets of low-income
households and beginning to feed into overall price
inflation in a number of economies. More important, rapid
growth in emerging and developing economies has narrowed or
in some cases closed output gaps in these economies.
Accordingly, overheating pressures are starting to
materialize in some cases. Consumer prices in these
economies are projected to rise 6 percent this year, an
upward revision of ¾ percentage point relative to the
October 2010 WEO. Signs of overheating are also becoming
apparent in some countries via rapid credit growth or rising
asset prices.
The picture is quite different in advanced economies,
where still-ample economic slack and well-anchored inflation
expectations will generally keep inflation pressures
subdued. Inflation is expected to remain at 1½ percent this
year, unchanged from 2010 and a slight upward revision from
the October 2010 WEO.
Downside risks remain elevated
Downside risks arise from the possibility of tensions in
the euro area periphery spreading to the core of Europe; the
lack of progress in formulating medium-term fiscal
consolidation plans in major advanced economies; the
continued weakness of the U.S. real estate market; high
commodity prices; and overheating and the potential for
boom-bust cycles in emerging markets. On the upside, there
are risks from stronger-than-expected business investment
rebounds in major advanced economies.
The risk of financial turmoil spreading from the
periphery to the core of Europe is a by-product of
continuing weakness among financial institutions in many of
the region’s advanced economies, and a lack of transparency
about their exposures. As a result, financial institutions
and sovereigns are closely linked, with spillovers between
the two sectors occurring in both directions. Although the
periphery accounts for only a small portion of the euro
area’s overall output and trade, substantial financial
linkages with countries in the core, as well as financial
spillovers through higher risk aversion and lower equity
prices, could generate a slowdown in growth and demand that
would hinder the global recovery. In particular, continued
market pressures could result in serious funding pressures
for major banks and sovereigns, increasing the likelihood
that problems spill over to core countries.
Figure 4 (CSV|PDF)
presents an alternative scenario that illustrates how larger
spillovers can subtract from growth. The scenario—which is
broadly similar to the one presented in the
July 2010 WEO Update—assumes that a large shock
followed by insufficiently rapid and strong policy action
results in significant losses on securities and credit in
the euro area periphery. This causes capital ratios to fall
substantially in several countries, both in the periphery
and the core. Under such a scenario, European banks tighten
lending conditions by a similar magnitude as during the
collapse of Lehman Brothers in 2008. As a result, euro area
growth is reduced by about 2½ percentage points relative to
the baseline. Assuming that financial spillovers to the rest
of the world are limited—with the increase in bank-lending
tightness in the United States about half that in
Europe—global growth in 2011 is lower by about 1 percentage
point than in the baseline. But if financial contagion to
the rest of the world is more severe—resulting in a spike in
generalized risk aversion, a drying up of liquidity, and
sharp falls in equity markets—the impact on global growth
would be substantially larger, amplified by balance sheet
weaknesses in other major advanced economies.
Another downside risk stems from insufficient progress in
developing medium-term fiscal consolidation plans in large
advanced economies. The recently implemented stimulus
measures in the United States and Japan make it more
challenging to ensure medium-term fiscal sustainability.
Therefore, it has become even more important to formulate
more credible plans to bring debt down over the medium term.
On the upside, business investment could rebound faster
than currently expected in key advanced economies,
underpinned by strong corporate sector profitability.
In emerging economies, key risks relate to overheating, a
rapid rise of inflation pressures, and the possibility of a
hard landing. In the near term, upside risks to growth have
risen, driven by accommodative policies, strong
terms-of-trade gains for commodity exporters, and resurgent
capital inflows. If, however, policymakers fall behind the
curve in responding to nascent overheating pressures and
asset price bubbles, macroeconomic policies in key emerging
economies could be setting the stage for boom-bust dynamics
in real estate and credit markets and, eventually, a hard
landing in these economies. With emerging markets now
accounting for almost 40 percent of global consumption and
more than two-thirds of global growth, a slowdown in these
economies would deal a serious blow to the global
recovery—and to the rebalancing that needs to take place.
Decisive policy actions are needed to lessen risks and
sustain growth
Despite the signs of near-term decoupling—between the
periphery and core of Europe, between financial stresses and
the real economy, and between advanced and emerging
economies—the global economy remains tightly interconnected.
A host of measures are needed in different countries to
reduce vulnerabilities and rebalance growth in order to
strengthen and sustain global growth in the years to come.
In the advanced economies, the most pressing needs are to
alleviate financial stress in the euro area and to push
forward with needed repairs and reforms of the financial
system as well as with medium-term fiscal consolidation.
Such growth-enhancing policies would help address
persistently high unemployment, a key challenge for these
economies. They would also produce beneficial spillovers to
emerging economies, where the main policy challenge is to
respond appropriately to capital inflows, keep overheating
pressures in check, and facilitate external rebalancing.
In the euro area, comprehensive, rapid, and decisive
policy actions are required to address downside risks.
Important steps at both the national and the euro-area-wide
level have been taken since May, including measures to
strengthen fiscal balances and introduce structural reforms,
the stepping up of extraordinary liquidity support and the
introduction of the Securities Markets Program by the
European Central Bank (ECB), and the establishment of the
temporary European Financial Stability Facility (EFSF), to
be succeeded by the permanent European Stability Mechanism (ESM)
after 2013. But additional strengthening of national policy
actions to further secure fiscal sustainability and rekindle
growth continues to be key in many countries. Markets remain
skittish about potential losses in the region’s banks and
have not been assuaged by stress tests conducted to date.
New stress tests that are more realistic, thorough, and
stringent will increase clarity. They will need to be
followed quickly by recapitalization. Markets also need to
be reassured that sufficient resources are available from
the center to deal with downside risks and that the overall
policy approach is consistent. Hence the EFSF as well as the
envisioned permanent ESM must have the ability to raise
sufficient resources and deploy them in a flexible manner,
as needed. In the meantime, the ECB will need to continue to
provide liquidity and remain active in securities purchases
to help preserve financial stability.
More generally in the advanced economies, there is a need
for continued progress to repair and reform financial
systems. This is a critical element of the normalization of
credit conditions and would help reduce the burden on
monetary and fiscal policy to support the recovery. The
specific financial sector policies needed are discussed in
more detail in the January 2011
Global Financial Stability Report Update.
The vulnerability of sovereigns emphasizes the urgency of
moving toward more sustainable fiscal paths—not just by
countries in the euro area periphery, but also by major
advanced economies. In the near term, emerging signs of a
handoff from public to private demand in many large advanced
economies suggests that countries can push forward in
formulating and implementing credible medium-term
consolidation plans. Although some targeted measures in the
United States are justifiable at this juncture given the
still weak labor and housing markets, the recently
implemented stimulus is expected to deliver only a
relatively small growth dividend (given its size) at a
considerable fiscal cost. The U.S. fiscal deficit is now
projected at 10¾ percent in 2011 (more than double that in
the euro area), and gross government debt is projected to
exceed 110 percent of GDP in 2016. The absence of a credible,
medium-term fiscal strategy would eventually drive up U.S.
interest rates, which could prove disruptive for global
financial markets and for the world economy. It is thus even
more critical that policies be put in place to bring debt
down over the medium term. Such measures could include
entitlement reforms, caps on discretionary spending, reforms
of the tax system to boost fiscal revenue, and the
establishment or strengthening of fiscal institutions.
Fiscal issues are discussed in more detail in the January
2011 Fiscal Monitor Update.
At the same time, monetary accommodation needs to
continue in the advanced economies. As long as inflation
expectations remain anchored and unemployment stays high,
this is the right policy from a domestic perspective.
Furthermore, it seems to have had an effect: following the
news in August that a second round of quantitative easing
was imminent, long-term rates fell to new lows in the United
States. Although U.S. Treasury yields have since increased,
particularly in the last quarter of 2010, this seems
primarily attributable to the improving outlook for the U.S.
economy, a fact corroborated by the strong performance of
equity markets. From an external perspective, however, there
is concern that quantitative easing in the United States
could result in a flood of capital outflows toward emerging
markets. The recent slowdown in capital inflows to emerging
markets suggests that such effects may be limited so far (Figure
5:
CSV|PDF).
In contrast, monetary tightening should begin or continue
in emerging economies where overheating pressures are
starting to emerge. Recent policy rate hikes by various
countries are welcome in this regard, although in some of
them more nominal exchange rate appreciation would have been
preferable. Such tightening can, however, exacerbate the
strong capital inflows that many of these economies are now
experiencing. Therefore, prudential measures to keep
increases in credit or asset markets from becoming excessive
should also be considered.
The renewed surge in capital inflows to some emerging
markets, whether driven by stronger fundamentals in the
emerging economies themselves or by looser monetary policy
in advanced economies, requires an appropriate policy
response. A number of these economies quickly overcame the
crisis and have continued to run current account surpluses (Figure
6:
CSV|PDF),
yet their real effective exchange rates remain close to
precrisis levels—that is, the response to renewed capital
inflows has been to accumulate even more foreign exchange
reserves. For these countries, allowing the currency to
appreciate would help combat overheating pressures and
facilitate a healthy rebalancing from external to domestic
demand. In other countries where the currency is above
levels consistent with medium-term fundamentals, fiscal
adjustment can help lower interest rates and restrain
domestic demand. Macroeconomic policy responses may, however,
need to be complemented by strengthened macro-prudential
measures (for example, stricter loan-to-value ratios,
funding composition restrictions) and, in some cases,
capital controls.
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