Group of Twenty - Meeting of G-20 Deputies

IMF Note on Global Economic Prospects and Effectiveness of Policy Response — Executive Summary

July 08, 2009

Executive Summary

Signs are emerging that the rate of decline in global activity is moderating, following two quarters of sharp contraction.

• The Fund’s projections for global growth have been revised modestly upwards, but the overall assessment remains that the global recovery will be sluggish, with risks tilted to the downside.
• Regional disparities are coming to the fore, with signs of renewed growth in Asia and stabilization in the United States, but more persistent weakness in Europe. Inflation will remain contained and upward pressures are not on the horizon, as output gaps continue to widen.

Financial conditions have eased, as wide-ranging policy actions begin to bear fruit, though the situation remains far from normal. The process of financial healing remains at an early stage and is still vulnerable to slippages in policy implementation or a renewed deterioration in macroeconomic conditions.

• In advanced economies, far-reaching public actions have helped to foster confidence, but more progress is needed on bank recapitalization and the resolution of impaired assets.
• In emerging economies, the prospects of stabilizing external demand, a broad recovery of commodity prices, and improving financial market conditions have somewhat eased the acute pressures. However, bank-related flows to emerging economies are likely to remain weak, reflecting global deleveraging, and some emerging markets remain extremely vulnerable.

Forceful implementation of policies is still required to build on the tangible results emerging from the policy actions taken so far to address the financial crisis. Specifically:

• Programs for the diagnosis of banking system soundness have progressed, albeit with substantial variation across countries. The use of bank-specific stress tests in the U.S. and increasingly in Europe is an important development toward repairing the financial system. Such approaches, involving bank-by-bank assessments, at least for major institutions, should be followed by appropriate disclosure of stress test results, recognition of losses, recapitalization initiatives, and, where relevant, restructuring or resolution of financial institutions.
• G-20 countries have taken steps to design and, in some cases, begin implementing strategies to deal with impaired assets, but success has been limited so far. To reduce balance sheet vulnerability and pave the way for banks to increase lending, further progress on resolving troubled assets is imperative, including by addressing urgently operational issues related to the valuation and disposal of these assets.
• Strengthening multilateral coordination to mitigate cross-border strains and distortion should remain a priority. The issue of cooperation extends beyond the design and implementation of stabilization policies, and would be particularly important as the crisis eases and support programs for financial institutions and markets are unwound.

Forceful monetary easing, including through unconventional measures, and large-scale provision of liquidity have reduced extreme stress in financial conditions.

• Monetary policy in major advanced economies should remain supportive until a sustained recovery takes hold. With monetary policy rates near zero and credit intermediation still impaired, advanced economy central banks should continue to explore unconventional measures. However, care is needed to limit central bank exposure to credit and market risk from such interventions.
• In emerging economies, monetary policy has to balance the need to support demand against the risk of exacerbating capital outflows. Those emerging economies that are less vulnerable to capital outflows and where core inflation has been well anchored have room for an accommodative monetary policy stance. Attention should also focus on formulating effective instruments to deal with risks of large-scale financial and corporate sector failures.

As for fiscal policy, countries should ensure in the near-term timely and effective implementation of the substantial fiscal stimulus in the pipeline, along with stepped up efforts to anchor medium-term expectations.

• Most G-20 countries appropriately stand ready to increase stimulus this year and next, as needed. Looking forward, early elaboration of clear and coherent exit strategies within comprehensive medium-term fiscal frameworks will be necessary to ease market concerns about the soundness of public finances. The strategies should include firm and credible commitments to reforming entitlements, actions to boost potential growth, fiscal consolidation, and other structural fiscal reforms.

As and when market conditions permit and the recovery becomes firmly established, credible and coherent exit strategies will be needed to unwind substantial public interventions in an orderly fashion.

• This will require coherent sequencing and clear communications by both fiscal and monetary authorities. Specific exit plans will need to be tailored to the various measures, some sooner than others, providing assurances on achieving medium-term policy goals, while avoiding the risk of a premature withdrawal of support. Multilateral coordination could mitigate possible cross-border distortions during exit.

The medium term path for the global economy as it moves beyond the crisis is likely to include a rebalancing of the sources of demand, and policy frameworks should facilitate this shift to sustain strong global growth.

• Both private and public savings will need to rise in the advanced economies for a sustained period to repair damage to balance sheets, while emerging economies will need to shift from external to domestic sources of demand.
• In major economies reliant on export-led growth over the past several years, policy frameworks should adjust to become more supportive of private demand, including policies to extend and strengthen social safety nets and to develop or deepen domestic financial systems. Greater exchange rate flexibility in some economies would also support a more fluid rebalancing between domestic and external sources of growth.
• Supply-side policies and structural reforms will also be important, to repair possible damage inflicted by the crisis on potential growth. Labor market reforms to enhance flexibility and mobility would help facilitate the sectoral shift in resources following the crisis; reabsorb rising numbers of unemployed; and reduce longer spells of inactivity which can feed into higher structural unemployment. Reforms in product and services markets to help strengthen competition and productivity could help mitigate the effects of tighter investment financing and a greater dependence on sectors geared toward meeting domestic demand.

• IMF and the Group of Twenty
• IMF Note on Stocktaking of the G-20 Responses to the Global Banking Crisis — March 13-14, 2009, London
• IMF Note on Global Economic Policies and Prospects — March 13-14, 2009, London
• World Economic Outlook Update — July 2009
• GFSR Market Update — July 2009