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19 February 2014

IMF note on global prospects and policy challenges

In its assessment ahead of the G20 meeting in Sydney, the IMF says recovery from the deep global recession has been disappointingly weak and urges stronger cooperation between developed and developing countries. It warns that deflation in the eurozone is a key new risk for the world economy.

Executive Summary

Global activity has picked up, largely on account of advanced economies. Growth firmed in 2013H2, driven largely by stronger outturns in advanced economies as final demand expanded broadly as expected. In many emerging markets, despite a boost to output from stronger exports, domestic demand has been weaker than expected, reflecting in part tighter financial conditions.

A new bout of financial volatility has affected emerging market economies as markets reassess their fundamentals. While the pressures were relatively broad-based, emerging economies with relatively high inflation and high current account deficits saw the largest asset price declines initially. Markets are showing signs of stabilising recently, although they are still fragile, on the back of actions by key emerging economies to shore up confidence and strengthen their policy commitments. This episode, however, underscores vulnerabilities and the challenging environment for many emerging economies. The rapid jump in global risk aversion had also driven down advanced economy equity prices.

The outlook remains broadly as projected in the January WEO, assuming that the impact of the recent financial volatility is short-lived. In advanced economies, less fiscal consolidation and relaxed financial conditions will support growth this year, while near-term prospects for emerging economies are broadly unchanged. Thus, global growth is projected to increase to about 3¾ per cent in 2014 (from 3 per cent in 2013) and 4 per cent in 2015, similar to the January 2014 WEO Update.

However, the recovery is still weak and significant downside risks remain. Capital outflows, higher interest rates, and sharp currency depreciation in emerging economies remain a key concern and a persistent tightening of financial conditions could undercut investment and growth in some countries given corporate vulnerabilities. A new risk stems from very low inflation in the euro area, where long-term inflation expectations might drift down, raising deflation risks in the event of a serious adverse shock to activity.

Further action and cooperation are needed to promote financial stability and robust recovery. Specifically:

  • Advanced economies should avoid premature withdrawal of monetary accommodation as fiscal balances continue consolidating. Given still large output gaps, very low inflation, and ongoing fiscal consolidation, monetary policy should remain accommodative in advanced economies. There is scope for better cooperation on unwinding UMP, including through wider central bank discussions of exit plans. In the euro area, repairing bank balance sheets remains critical to monetary policy transmission. Finally, fiscal consolidation should proceed at a measured pace, while preserving the long-run growth potential of the economy.
  • In emerging market economies, credible macroeconomic policies and frameworks, alongside exchange rate flexibility, are critical to weather turbulence. Further monetary policy tightening in the context of strengthened policy frameworks is necessary where inflation is still relatively high or where policy credibility has come into question. Priority should also be given to shoring up fiscal policy credibility where it is lacking; subsequently buffers should be built to provide space for counter-cyclical policy action. Exchange rate flexibility should continue to facilitate external adjustment, particularly where currencies are overvalued, while FX intervention—where reserves are adequate—can be used to smooth excessive volatility or prevent financial disruption.
  • Further policy actions are needed to reduce unemployment and strengthen medium-term growth, while making it more balanced. Key policies to boost potential include competition-enhancing product market reforms, infrastructure investment, and labour participation reforms, while further action is needed to avoid a resurgence of global imbalances as the recovery proceeds and ensure sustainable medium-term growth.

Full note

"A new risk stems from very low inflation in the euro area, where long-term inflation expectations might drift down, raising deflation risks in the event of a serious adverse shock to activity", the Fund said. It added that the eurozone was "turning the corner" from recession to a recovery that was uneven and fragile. Low inflation added to the problems of the troubled countries on the fringes of the euro area, where it would increase the real burden of already high levels of public debt.

"In the euro area, more monetary easing is needed to raise the prospects of achieving the ECB's inflation objective, including by supporting demand, given the weak and fragile growth, large output gaps and very low inflation", said the Washington-based IMF. It said further ECB action could include cheap loan schemes, possibly targeted at small and medium sized firms, and "further rate cuts, including mildly negative deposit rates, to support demand and reduce fragmentation".

"There is scope for better cooperation on unwinding unconventional monetary policies, including through wider central bank discussions of exit plans. In the euro area, repairing bank balance sheets remains critical to monetary policy transmission."

Further reporting © The Guardian

© International Monetary Fund

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