Driving the Global Economy with the Brakes On

After the speech by the IMF's Managing Director in Berlin yesterday, my main messages on the global outlook will not surprise you.

Starting with the bad news -- the world recovery, which was weak in the first place, is in danger of stalling. The epicenter of the danger is Europe, but the rest of the world is increasingly affected.

There is an even greater danger, namely that the European crisis intensifies. In this case, the world could be plunged into another recession.

Turning to the good news -- with the right set of measures, the worst can definitely be avoided, and the recovery can be put back on track. These measures can be taken, need to be taken, and need to be taken urgently.

And now the numbers, starting at the epicenter:

The IMF's forecast for growth in Euro Area for 2012 is ‑0.5 percent -- this marks a decrease of 1.6 percentage points relative to our September 2011 projection. In particular, we predict negative growth in Italy (‑2.2 percent) and Spain (‑1.7 percent).

We have also revised downwards our forecasts for other advanced countries, although by less. Only for the United States, is our forecast unchanged at 1.8 percent.

The growth outlook in emerging and developing countries is also down, at 5.4 percent, a decrease of 0.7 percent relative to our September forecast. The revision is particularly sharp in Central and Eastern Europe, reflecting their links to the Euro area. But it is also substantial in China and India, where internal factors explain most of the decrease.

What are the forces behind these numbers?

Most advanced economies are operating with two major brakes on.

• The first is fiscal consolidation. Consolidation is necessary -- debt levels are very high -- but, in the short run, it is clearly a drag on demand, it is a drag on growth.
• The second is tight credit. In many countries, particularly in Europe, banks are still weak. They are deleveraging. And, in many cases, deleveraging means tighter credit to households or firms, another drag on growth. With those brakes on, the recovery cannot be very strong, and indeed this is something you see in past financial crises.

What is happening in Europe, however, is making things worse.

Doubts about fiscal sustainability are leading to high yields on sovereign bonds and, in turn, doubts about bank solvency. To reassure markets, governments have felt they had to consolidate further. To reassure investors, banks have deleveraged and tightened credit. Both actions have further decreased growth, leading to a dangerous downward spiral.

This explains our forecasts of negative growth for some of the Euro periphery countries, and low growth in the rest of the Euro area. Looking beyond Europe, spillovers through trade are already visible among Euro trade partners. And bouts of risk aversion and uncertainty are leading to high volatility of capital flows to emerging markets.

If not contained, this downward spiral can lead to even worse outcomes, be it disorderly default or Euro exit, with major spillovers, first to the rest of the Euro area, and then to the rest of the world.

In this context, the required policies are clear.

These are largely a repeat of the main messages from the Managing Director Christine Lagarde's speech yesterday.

• First, fiscal consolidation must proceed, but at an appropriate pace. Decreasing debt is a marathon, not a sprint. Going too fast will kill growth, and further derail the recovery. It took more than two decades to successfully decrease debt from its World War II heights. We should expect that it may take as long or longer this time.

Of the essence here is a credible medium term plan, something still missing in the United States and Japan. Once such a plan is in place, in most countries, automatic stabilizers should be left to play. In some countries, slower consolidation may even be appropriate.


• Second, a credit crunch must be avoided. Where banks need to increase their capital ratios, they should do it through an increase in capital, rather than a decrease in credit. Recapitalization through public funds will help credit, sustain activity, and may actually improve the fiscal outlook.
• Third, and to the extent that they are taking the tough measures they need to take, Euro periphery countries -- such as Italy or Spain -- must be able to borrow at low interest rates. As many investors have left the market and are unlikely to return soon, public liquidity provision may be needed. It can be provided in various ways, by the European Central Bank, by the European Union, and by the IMF. Whichever combination is used, the available funds must be large enough to maintain low interest rates and fiscal sustainability.

Our forecasts are based on the assumption that these measures will be adopted, and the euro crisis will slowly decrease in intensity. If they are not, one can fear the worst. If they are adopted decisively, the world economy may perform better than our forecast.

One should be under no illusion however. Even then, the brakes will still be on, and unemployment will decrease only slowly. We have a long way to go before the world economy has fully recovered.

From iMFdirect blog

 

Comments

[Kenneth Alton]

03:17 PM on 01/25/2012

"... Recapitalization through public funds will help credit, sustain activity, and may actually improve the fiscal outlook..."

For a very short time perhaps. Then the consequences of further moral hazard will set in, as individuals within said recapitalized banks find new and even more interesting ways to gamble with the public's money risk free (to themselves) in pursuit of more private wealth (for themselves). And then the next wave of financial collapse will hit, and it will make the last look like a mere ripple.

Rather than recapitalizing failed banking and financial institutions, it might be better to seize them and confiscate their assets. And to ensure that moral hazard is not perpetuated - all high ranking employees of said seized institutions should be barred from working in the financial industry or any related industry for life. Further, any bonuses or private profits from some of the more egregious practices of the last decade should be treated as gains from a criminal enterprise and likewise seized from the individuals or institutions who so profited. The resulting boost to public liquidity can then be used to mitigate the financial dislocations caused by fiscal consolidation.

[Realist2011]

12:34 PM on 01/25/2012

It doesn't surprise me that the IMF, the banker's bank of the world believes that the same things that have brought us into the middle of this mess, will cure it. The IMF and their Wall Street/Market/Banker owners are delusional. The entire lot of them should be institutionalized.

The "cure" is to completely dump every derivative. Mark them "Null and Void" and shred them. When you can't "hedge" your risk with these financial innovations, perhaps you'll start assessing risk properly and invest using common sense.

Oh, and of course, dump the Fed here in the US, shackle the Treasury and remove ourselves from the UN and the IMF. They're both "money pits" that are a financial drain and pose significant dangers to America.

[Henry]

10:43 AM on 01/25/2012

More people are beginning to realize that their economy should be local. Bank locally, purchase products made in America, and invest locally. Factor price equilibrium of wages that compare a $3000 U.S. annual salary equivalent to compete to American labor at $30000 is unfair to Americans. The free enterprise competition stops at an equilibrium which would be $21000 for each worker, the Chinese and the American. This hurts the American and he has no interest in this. However, the American enterprise (WalMart) loves this as the cost of goods to them beats the American competition. This was never explained to the American worker. And these boys expect the pledge of allegience to be uttered. ugh.

[Genders]

10:51 PM on 01/24/2012

You TOTALLY don't get it. The banksters robbed the world and you are afraid to reign them in.

[Kenneth Alton]

03:40 PM on 01/25/2012

He is a Chief Economist and Director within the International Monetary Fund; in essence he is both a banker and a politician. Despite his academic credentials or his private wishes or thoughts, he is absolutely obligated to preserve and protect the system as it stands while offering solutions within said system to stabilize the wider economies and existing financial institutions. That is his job.

What he cannot do is publicly offer up any solutions that would adversely impact any important member of the financial community, e.g., suggesting somebody "reign them in". As members of the voting public, that's our job - to change the legislatures and in doing so hopefully change the relationship between the banks and our representative governments.

Ironically, our duty is also to listen to Monsieur Blanchard and ponder what he has says. If we like what he proposes, if he explains himself well, good. If what he says does not meet with our approval we can propose something else, try to change our governments by choosing candidates who do not hold the IMF's world-view, and quite possibly put him and his colleagues out of a job.

[Genders]

07:01 PM on 01/25/2012

Bankster nonsense, sorry. FDR'em. he's the one who publicly called them banksters. For a reason, the whole the banking system has become a fraud.

Kiss the banksters rings? h no.

The Banksters Robbed us of trillions. The federal Reserve has given them , at .004%, about 16 trillion more, plus 10T$ to foreign banksters. That becomes 260T$ with fractional reserve, that more than the value of the world businesses. Arrest the Banksters for the Fraud: SWAPS and CDO's. Federal reserve system.

Watch "the Money Masters"
http://www.themoneymasters.com/
http://webskeptic.wikidot.com/money-masters-transcripts-part-24
Bankster now literally own us.
http://en.wikipedia.org/wiki/File:Estimated_ownership_of_treasury_securities_by_year.gif

Phase out fractional reserve while issuing greenbacks. That creates a debt free monetary system

“The Government should create, issue, and circulate all the currency and credits needed to satisfy the spending power of the Government and the buying power of consumers. By the adoption of these principles, the taxpayers will be saved immense sums of interest. Money will cease to be master and become the servant of humanity.” Abraham Lincoln

Kucinich http://www.monetary.org/wp-content/uploads/2011/10/HR-2990.pdf Greenbacks!