In various guises, the “Year of Living Dangerously” has been used to describe the global financial crisis, the policy response to the crisis, and its aftermath. But, we’ve slipped well beyond a year and the financial system is still flirting with danger. Financial stability risks may have eased, reflecting improvements in the economic outlook and continuing accommodative policies. But those supportive policies—while necessary to restart the economy—have also masked serious, underlying financial vulnerabilities that need to be addressed as quickly as possible. Many advanced economies are “living dangerously” because the legacy of high debt burdens is weighing on economic activity and balance sheets, keeping risks to financial stability elevated. At the same time, many emerging market countries risk overheating and the build-up of financial imbalances—in the context of rapid credit growth, increasing asset prices, and strong and volatile capital inflows. Here is our suggested roadmap for policymakers to address these vulnerabilities and risks, and achieve durable financial stability.
The world economic recovery is gaining strength, but it remains unbalanced. Earlier fears of a double dip recession—which we did not share—have not materialized. And, although rising commodity prices conjure the specter of 1970s-style stagflation, they appear unlikely to derail the recovery. However, the unbalanced recovery confronts policy makers with difficult choices. In most advanced economies, output is still far below potential. Low growth implies that unemployment will remain high for many years to come. And the problems in Europe’s periphery are particularly acute. On the other end of the spectrum, emerging market countries must avoid overheating in the face of closing output gaps and higher capital flows. The need for careful design of macroeconomic policies at the national level, and coordination at the global level, may be as important today as they were at the peak of the crisis two years ago.
Of all the things policymakers have had to worry about in the past couple of years, inflation wasn’t one of them. Some even heralded the end of inflation. Today, inflation still isn’t a ‘problem’ in Asia. For the most part, it remains relatively modest, but it is on the rise in some countries in the region. And understanding what is driving that inflation matters. Policymakers need to consider the sources of inflation in choosing policy actions and policy tools. The issue of what drives inflation—or so-called inflation dynamics—is examined in our October 2010 Regional Economic Outlook for the Asia and Pacific region. In this post, Anoop Singh discusses the findings.
I am in Asia this week to launch our October 2010 Regional Economic Outlook: Asia and Pacific (REO) in Jakarta and Singapore. As I have inevitably found during visits to Asia over so many years, the mood here is confident about future economic prospects. Yet it is also watchful for risks that may be lurking over the horizon. This mood matches closely the main messages of our current assessment of the outlook for the region. In the first of several blogs posts from the region, here I reflect on the self-sustaining recovery under way across Asia, the risk external risk factors and, the pressing issue for Asian policymakers, policy options for managing the tide of large capital inflows.
Almost unnoticed amidst the difficulties in western Europe, the other half of the continent has begun to recover from the deepest slump in its post-transition period. In our fall 2010 Regional Economic Outlook, the emerging economies in central and eastern Europe are projected to grow by 3¾ percent this year and next—a relief after the 6 percent decline in 2009. But the boom years before the crisis had left much of the region addicted to foreign-financed credit growth, making it very vulnerable to a disruption in capital inflows. So, as the region emerges from the crisis, the big question is how do we avoid a repeat?
Achieving a “strong, balanced, and sustained world recovery”—to quote from the goal set in Pittsburgh by the G-20—was never going to be easy. It requires much more than just going back to business as usual. It requires two fundamental and complex economic rebalancing acts: internal and external rebalancing. These two rebalancing acts are taking place too slowly. As the latest World Economic Outlook reveals, the result is a recovery which is neither strong, nor balanced, and runs the risk of not being sustained.
It would be unfair for any assessment of global economic and financial stability not to acknowledge the tremendous progress has been made in repairing and strengthening the financial system since the onset of the global crisis. Still, the key message from the IMF’s October 2010 Global Financial Stability Report is clear. Progress toward global financial stability has suffered a setback over the past six months—the financial system remains the Achilles’ heel of the economic recovery. In this blog post, José Viñals discusses two broad issues. What is at the heart of this lingering lack of confidence? And, looking ahead, what are the policy priorities?
History has shown that persistent and large capital inflows can be a double edged sword. While they bring with them numerous benefits, they do pose risks and policy dilemmas. Continued large capital flows pose, for example, the risk of overheating and runups in asset prices that may subsequently render the region vulnerable to outflows and asset price busts.
Not so long after the global financial crisis, the supply of foreign financing has become abundant, and cheap, for many emerging market countries. This sounds like good news for Latin America, and it is—creating opportunities for debt management, saving on interest paid to foreigners, and expanding opportunities for investment. But it also comes with a number of potential risks that need to be managed.
Our new Regional Economic Outlook for the Western Hemisphere takes an in-depth look at the risks arising from what we call “easy external financial conditions.” There we analyze how the more financially integrated economies of Latin America have responded to such conditions in the past, with comparison to countries of other regions. Our comparisons focus especially on a group of advanced economies—Canada, Australia and New Zealand, and Norway—that also are commodity exporters, as well as being inflation targeters with highly flexible exchange rates.