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Wor l d Eco no mic a nd F i na nci a l S ur v e y s

World Economic Outlook

Crisis and Recovery

World Economic and Financial Surveys


April 2009

Crisis and Recovery

International Monetary Fund

©2009 International Monetary Fund

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World economic outlook (International Monetary Fund)

World economic outlook : a survey by the staff of the International Monetary
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Assumptions and Conventions ix

Preface xi

Joint Foreword to World Economic Outlook and Global Financial Stability Report xii

Executive Summary xv

Chapter 1. Global Prospects and Policies 1

How Did Things Get So Bad, So Fast? 2
Short-Term Prospects Are Precarious 9
Medium-Term Prospects beyond the Crisis 27
Policies to End the Crisis while Paving the Way to Sustained Recovery 32
Appendix 1.1. Commodity Market Developments and Prospects 44
Appendix 1.2. Fan Chart for Global Growth 55
Appendix 1.3. Assumptions behind the Downside Scenario 58
References 60

Chapter 2. Country and Regional Perspectives 63

The United States Is Grappling with the Financial Core of the Crisis 63
Asia Is Struggling to Rebalance Growth from External to Domestic Sources 71
Europe Is Searching for a Coherent Policy Response 75
The CIS Economies Are Suffering a Triple Blow 84
Other Advanced Economies Are Dealing with Adverse Terms-of-Trade Shocks 86
Latin America and the Caribbean Face Growing Pressures 87
Middle Eastern Economies Are Buffering Global Shocks 91
Hard-Won Economic Gains in Africa Are Being Threatened 93
References 95

Chapter 3. From Recession to Recovery: How Soon and How Strong? 97

Business Cycles in the Advanced Economies 98
Does the Cause of a Downturn Affect the Shape of the Cycle? 106
Can Policies Play a Useful Countercyclical Role? 113
Lessons for the Current Recession and Prospects for Recovery 123
Appendix 3.1. Data Sources and Methodologies 126
References 130


Chapter 4. How Linkages Fuel the Fire: The Transmission of Financial Stress
from Advanced to Emerging Economies 133
Measuring Financial Stress 136
Links between Advanced and Emerging Economies 141
The Transmission of Financial Stress: An Overall Analysis 147
Lessons from Previous Advanced Economy Banking Crises 155
Implications for the Current Crisis 157
Which Policies Can Help? 159
Appendix 4.1. A Financial Stress Index for Emerging Economies 160
Appendix 4.2. Financial Stress in Emerging Economies: Econometric Analysis 162
References 166

Annex: IMF Executive Board Discussion of the Outlook, April 2009 171

Statistical Appendix 175

Assumptions 175
What’s New 180
Data and Conventions 180
Classification of Countries 182
General Features and Composition of Groups in the World Economic
Outlook Classification 184
List of Tables
Output (Tables A1–A4) 189
Inflation (Tables A5–A7) 197
Financial Policies (Table A8) 203
Foreign Trade (Table A9) 204
Current Account Transactions (Tables A10–A12) 206
Balance of Payments and External Financing (Tables A13–A15) 212
Flow of Funds (Table A16) 216
Medium-Term Baseline Scenario (Table A17) 220

World Economic Outlook, Selected Topics 221

1.1 Global Business Cycles 11
1.2 How Vulnerable Are Nonfinancial Firms? 20
1.3 Assessing Deflation Risks in the G3 Economies 24
1.4 Global Imbalances and the Financial Crisis 34
1.5 Will Commodity Prices Rise Again when the Global Economy Recovers? 47
2.1 The Case of Vanishing Household Wealth 66
2.2 Vulnerabilities in Emerging Economies 79
3.1 How Similar Is the Current Crisis to the Great Depression? 99
3.2 Is Credit a Vital Ingredient for Recovery? Evidence from Industry-Level Data 115
4.1 Impact of Foreign Bank Ownership during Home-Grown Crises 158
A1. Economic Policy Assumptions Underlying the Projections for Selected Economies 176


1.1 Overview of the World Economic Outlook Projections 10
1.2 Comparison of Commodity Price Volatility 46
1.3 Global Oil Demand and Production by Region 53
1.4 Underlying World Merchandise Trade Flows 59
1.5 Factors Explaining the Additional Decline in Output Growth for 2009–10 59
2.1 Advanced Economies: Real GDP, Consumer Prices, and Unemployment 65
2.2 Selected Asian Economies: Real GDP, Consumer Prices, and Current Account Balance 73
2.3 Advanced Economies: Current Account Positions 74
2.4 Selected Emerging European Economies: Real GDP, Consumer Prices, and
Current Account Balance 78
2.5 Selected Commonwealth of Independent States Economies: Real GDP,
Consumer Prices, and Current Account Balance 86
2.6 Selected Western Hemisphere Economies: Real GDP, Consumer Prices, and
Current Account Balance 90
2.7 Selected Middle Eastern Economies: Real GDP, Consumer Prices, and
Current Account Balance 92
2.8 Selected African Economies: Real GDP, Consumer Prices, and Current Account Balance 94
3.1 Business Cycles in the Industrial Countries: Summary Statistics 105
3.2 Financial Crises and Associated Recessions 107
3.3 Impact of Policies on the Probability of Exiting a Recession 123
3.4 Impact of Policies on the Strength of Recoveries 124
3.5 Results from Categorizing Recessions 128
3.6 Financial Crises and Deregulation in the Mortgage Market 129
3.7 Impact of Policies on the Strength of Recoveries Using an Alternative Measure of
Fiscal Policy 130
4.1 Episodes of Widespread Financial Stress in Advanced Economies 138
4.2 The Role of Linkages as Determinants of Comovement 152
4.3 Emerging Economy Stress: Country-Specific Effects 153
4.4 Emerging Economy Stress: Determinants of Common Time Trend 163
4.5 Emerging Economy Stress: Country-Specific Effects and Interactions with Stress
in Advanced Economies 166

1.1 Global Indicators 1
1.2 Developments in Mature Credit Markets 2
1.3 Emerging Market Conditions 3
1.4 Current and Forward-Looking Indicators 4
1.5 Global Inflation 5
1.6 External Developments 6
1.7 Measures of Monetary Policy and Liquidity in Selected Advanced Economies 7
1.8 Global Outlook 15
1.9 Potential Growth and the Output Gap 16
1.10 Risks to World GDP Growth 17
1.11 Housing Developments 18
1.12 Downside Scenario 27


1.13 Net Capital Flows to Emerging and Developing Economies 29

1.14 General Government Fiscal Balances and Public Debt 30
1.15 Global Saving, Investment, and Current Accounts 31
1.16 Alternative Medium-Term Scenarios 33
1.17 Commodity and Petroleum Prices 45
1.18 World Oil Market Developments 52
1.19 Developments in Metal and Energy Markets 54
1.20 Recent Developments in Markets for Major Food Crops 55
1.21 Dispersion of Forecasts and Selected Risk Factors 58
1.22 Balance of Risks Associated with Selected Risk Factors 60
2.1 United States: The Center of the Crisis 64
2.2 Advanced and Emerging Asia: Suffering from the Collapse of Global Trade 72
2.3 Europe: Developing a Common Response 76
2.4 Europe: Subdued Medium-Run Growth Prospects 77
2.5 Commonwealth of Independent States: Struggling with Capital Outflows 85
2.6 Canada, Australia, and New Zealand: Dealing with Terms-of-Trade Shocks 88
2.7 Latin America: Pressures Are Growing 89
2.8 Middle East: Coping with Lower Oil Prices 91
2.9 Africa: Hard-Won Gains at Risk 93
3.1 Business Cycle Peaks and Troughs 104
3.2 Business Cycles Have Moderated over Time 104
3.3 Temporal Evolution of Recessions by Shock 107
3.4 Average Statistics for Recessions and Recoveries 108
3.5 Expansions in the Run-Up to Recessions Associated with Financial Crises and
Other Shocks 109
3.6 House Price-to-Rental Ratios for Recessions Associated with Financial Crises and
Other Shocks 110
3.7 Household Saving Rate and Net Lending before and after Business Cycle Peaks 111
3.8 Recessions and Recoveries Associated with Financial Crises and Other Shocks 112
3.9 Highly Synchronized Recessions 113
3.10 Are Highly Synchronized Recessions Different? 114
3.11 Average Policy Response during a Recession 119
3.12 Impact of Policies during Financial Crisis Episodes 120
3.13 Effect of Policy Variables on the Strength of Recovery 121
3.14 Relationship between the Impact of Fiscal Policy on the Strength of Recovery and
Debt-to-GDP Ratio 122
3.15 Economic Indicators around Peaks of Current and Previous Recessions 125
4.1 Indicators of Financial Stress in Emerging Economies 134
4.2 Capital Flows to Emerging Economies 135
4.3 Sudden Stops and Activity 136
4.4 Financial Stress in Advanced Economies 137
4.5 Financial Stress Indices in Emerging Economies 141
4.6 Financial Stress in Emerging and Advanced Economies 142
4.7 The Transmission of Stress: Schematic Depiction of Effects 143
4.8 Financial Integration of Emerging and Developing Economies 144
4.9 Financial Exposures of Emerging to Advanced Economies 146
4.10 Financial Linkages between Advanced and Emerging Economies 147


4.11 Vulnerability Indicators by Region, 1990–2007 148

4.12 Comovement in Financial Stress between Emerging and Advanced Economies 150
4.13 Explaining Financial Stress in Emerging Economies 154
4.14 Impact of the Latin American Debt Crisis on Banking Liabilities 156
4.15 Impact of the Japanese Banking Crisis on Bank Lending 157
4.16 Exposure to Bank-Lending Liabilities and Twin Deficits in Emerging
Economies, 2002–06 159
4.17 Emerging Economy Stress: Common Time Component and Stress
in Advanced Economies 162


A number of assumptions have been adopted for the projections presented in the World Economic
Outlook. It has been assumed that real effective exchange rates remain constant at their average levels
during February 25–March 25, 2009, except for the currencies participating in the European exchange
rate mechanism II (ERM II), which are assumed to remain constant in nominal terms relative to the
euro; that established policies of national authorities will be maintained (for specific assumptions
about fiscal and monetary policies for selected economies, see Box A1); that the average price of oil
will be $52.00 a barrel in 2009 and $62.50 a barrel in 2010, and will remain unchanged in real terms
over the medium term; that the six-month London interbank offered rate (LIBOR) on U.S. dollar
deposits will average 1.5 percent in 2009 and 1.4 percent in 2010; that the three-month euro deposit
rate will average 1.6 percent in 2009 and 2.0 percent in 2010; and that the six-month Japanese yen
deposit rate will yield an average of 1.0 percent in 2009 and 0.5 percent in 2010. These are, of course,
working hypotheses rather than forecasts, and the uncertainties surrounding them add to the margin
of error in the projections. The estimates and projections are based on statistical information available
through mid-April 2009.
The following conventions are used throughout the World Economic Outlook:
... to indicate that data are not available or not applicable;
– between years or months (for example, 2006–07 or January–June) to indicate the years or
months covered, including the beginning and ending years or months;
/ between years or months (for example, 2006/07) to indicate a fiscal or financial year.
“Billion” means a thousand million; “trillion” means a thousand billion.
“Basis points” refer to hundredths of 1 percentage point (for example, 25 basis points are equivalent
to ¼ of 1 percentage point).
In figures and tables, shaded areas indicate IMF staff projections.
If no source is listed on tables and figures, data are drawn from the World Economic Outlook
(WEO) database.
When countries are not listed alphabetically, they are ordered on the basis of economic size.
Minor discrepancies between sums of constituent figures and totals shown reflect rounding.
As used in this report, the term “country” does not in all cases refer to a territorial entity that is a
state as understood by international law and practice. As used here, the term also covers some territo-
rial entities that are not states but for which statistical data are maintained on a separate and indepen-
dent basis.


This version of the World Economic Outlook is available in full on the IMF’s website,
Accompanying it on the website is a larger compilation of data from the WEO database than is
included in the report itself, including files containing the series most frequently requested by readers.
These files may be downloaded for use in a variety of software packages.
Inquiries about the content of the World Economic Outlook and the WEO database should be sent by
mail, e-mail, or fax (telephone inquiries cannot be accepted) to

World Economic Studies Division

Research Department
International Monetary Fund
700 19th Street, N.W.
Washington, D.C. 20431, U.S.A.
Internet: Fax: (202) 623-6343


The analysis and projections contained in the World Economic Outlook are integral elements of the
IMF’s surveillance of economic developments and policies in its member countries, of developments
in international financial markets, and of the global economic system. The survey of prospects and
policies is the product of a comprehensive interdepartmental review of world economic developments,
which draws primarily on information the IMF staff gathers through its consultations with member
countries. These consultations are carried out in particular by the IMF’s area departments together
with the Strategy, Policy, and Review Department, the Monetary and Capital Markets Department, and
the Fiscal Affairs Department.
The analysis in this report was coordinated in the Research Department under the general direc-
tion of Olivier Blanchard, Economic Counsellor and Director of Research. The project was directed
by Charles Collyns, Deputy Director of the Research Department, and Jörg Decressin, Division Chief,
Research Department.
The primary contributors to this report are Ravi Balakrishnan, Jaromir Benes, Petya Koeva Brooks,
Kevin Cheng, Stephan Danninger, Selim Elekdag, Thomas Helbling, Prakash Kannan, Douglas Laxton,
Alasdair Scott, Natalia Tamirisa, Marco Terrones, and Irina Tytell. Toh Kuan, Gavin Asdorian, Stepha-
nie Denis, Murad Omoev, Jair Rodriguez, Ercument Tulun, and Jessie Yang provided research assis-
tance. Saurabh Gupta, Mahnaz Hemmati, Laurent Meister, and Emory Oakes managed the database
and the computer systems. Jemille Colon, Tita Gunio, Shanti Karunaratne, Patricia Medina, and Sheila
Tomilloso Igcasenza were responsible for word processing. Julio Prego provided graphics support.
Other contributors include Kevin Clinton, Dale Gray, Marianne Johnson, Ondrej Kamenik, Ayhan
Kose, Prakash Loungani, David Low, and Dirk Muir. Menzi Chinn and Don Harding were external
consultants. Linda Griffin Kean of the External Relations Department edited the manuscript and coor-
dinated the production of the publication.
The analysis has benefited from comments and suggestions by staff from other IMF departments, as
well as by Executive Directors following their discussion of the report on April 13, 2009. However, both
projections and policy considerations are those of the IMF staff and should not be attributed to Execu-
tive Directors or to their national authorities.


Prospects interest rates are expected to be lowered to

or remain near the zero bound in the major
Even with determined steps to return the
advanced economies, while central banks con-
financial sector to health and continued use of
tinue to explore unconventional ways to ease
macroeconomic policy levers to support aggre-
credit conditions and provide liquidity. Fiscal
gate demand, global activity is projected to
deficits are expected to widen sharply in both
contract by 1.3 percent in 2009. This represents
advanced and emerging economies, on assump-
the deepest post–World War II recession by far.
tions that automatic stabilizers are allowed to
Moreover, the downturn is truly global: output
per capita is projected to decline in countries operate and governments in G20 countries
representing three-quarters of the global econ- implement fiscal stimulus plans amounting to
omy. Growth is projected to reemerge in 2010, 2 percent of GDP in 2009 and 1½ percent of
but at 1.9 percent it would be sluggish relative to GDP in 2010.1
past recoveries. The current outlook is exceptionally uncer-
These projections are based on an assess- tain, with risks still weighing on the downside. A
ment that financial market stabilization will take key concern is that policies may be insufficient
longer than previously envisaged, even with to arrest the negative feedback between dete-
strong efforts by policymakers. Thus, financial riorating financial conditions and weakening
conditions in the mature markets are projected economies in the face of limited public support
to improve only slowly, as insolvency concerns for policy actions.
are diminished by greater clarity over losses
on bad assets and injections of public capital,
Policy Challenges
and counterparty risks and market volatility
are reduced. The April 2009 issue of the Global The difficult and uncertain outlook argues for
Financial Stability Report (GFSR) estimates that, continued forceful action both on the financial
subject to a number of assumptions, credit write- and macroeconomic policy fronts to establish
downs on U.S.-originated assets by all holders the conditions for a return to sustained growth.
since the start of the crisis will total $2.7 trillion, Whereas policies must be centered at the
compared with an estimate of $2.2 trillion in national level, greater international cooperation
the January 2009 GFSR Update. Including assets is needed to avoid exacerbating cross-border
originated in other mature market economies, strains. Building on the positive momentum
total write-downs could reach $4 trillion over created by the April G20 summit in London,
the next two years, approximately two-thirds of coordination and collaboration is particularly
which may be taken by banks. Overall credit to important with respect to financial policies
the private sector in the advanced economies to avoid adverse international spillovers from
is thus expected to decline during both 2009 national actions. At the same time, international
and 2010. Because of the acute degree of stress support, including the additional resources
in mature markets and its concentration in the
banking system, capital flows to emerging econo- Group of 20 comprises 19 countries (Argentina,
mies will remain very low. Australia, Brazil, Canada, China, France, Germany, India,
Indonesia, Italy, Japan, Mexico, Republic of Korea, Rus-
The projections also assume continued strong sia. Saudi Arabia, South Africa, Turkey, United Kingdom,
macroeconomic policy support. Monetary policy and United States) and the European Union.


being made available to the IMF, can help Wide-ranging efforts to deal with financial
countries buffer the impact of the financial crisis strains in both the banking and corporate sec-
on real activity and limit the fallout on poverty, tors will also be needed in emerging economies.
particularly in developing economies. Direct government support for corporate bor-
rowing may be warranted. Some countries have
also extended public guarantees of bank debt to
Repairing Financial Sectors the corporate sector and provided backstops to
The greatest policy priority for ensuring a dura- trade finance. Additionally, contingency plans
ble economic recovery is restoring the financial should be devised to prepare for potential large-
sector to health. The three priorities identified in scale restructurings if circumstances deteriorate
previous issues of the GFSR remain relevant: (1) further.
ensuring that financial institutions have access
to liquidity, (2) identifying and dealing with
distressed assets, and (3) recapitalizing weak but Supporting Aggregate Demand
viable institutions and resolving failed institutions. In advanced economies, room to further ease
The critical underpinning of an enduring monetary policy should be used forcefully to
solution must be credible loss recognition on support demand and counter deflationary risks.
impaired assets. To that end, governments need With the scope for lowering interest rates now
to establish common basic methodologies for a virtually exhausted, central banks will have to
realistic, forward-looking valuation of securitized continue exploring less conventional measures,
credit instruments. Various approaches to deal- using both the size and composition of their own
ing with bad assets in banks can work, provided balance sheets to support credit intermediation.
they are supported with adequate funding and Emerging economies also need to ease mon-
implemented in a transparent manner. etary conditions to respond to the deteriorating
Bank recapitalization must be rooted in a outlook. However, in many of those economies,
careful evaluation of the prospective viability the task of the central bank is further compli-
of institutions, taking into account both write- cated by the need to sustain external stability
downs to date and a realistic assessment of in the face of highly fragile financing flows and
prospects for further write-downs. As supervisors balance sheet mismatches because of domestic
assess recapitalization needs on a bank-by-bank borrowing in foreign currencies. Thus, although
basis, they must assure themselves of the quality central banks in most of these economies have
of the bank’s capital and the robustness of its lowered interest rates in the face of the global
funding, its business plan and risk-management downturn, they have been appropriately cau-
processes, the appropriateness of compensa- tious in doing so to maintain incentives for
tion policies, and the strength of management. capital inflows and to avoid disorderly exchange
Viable financial institutions that are undercapi- rate moves.
talized need to be intervened promptly, possibly Given the extent of the downturn and the
utilizing a temporary period of public ownership limits to monetary policy action, fiscal policy
until a private sector solution can be developed. must play a crucial part in providing short-term
Nonviable institutions should be intervened support to the global economy. Governments
promptly, which may entail orderly closures or have acted to provide substantial stimulus in
mergers. In general, public support to the finan- 2009, but it is now apparent that the effort will
cial sector should be temporary and withdrawn need to be at least sustained, if not increased,
at the earliest opportunity. The amount of in 2010, and countries with fiscal room should
public funding needed is likely to be large, but stand ready to introduce new stimulus measures
the requirements will rise the longer it takes for as needed to support the recovery. However, the
a solution to be implemented. room to provide fiscal support will be limited


if such efforts erode credibility. In advanced ing for a number of these economies. The G20
economies, credibility requires addressing the agreement to increase the resources available
medium-term fiscal challenges posed by aging to the IMF will facilitate further support. Also,
populations. The costs of the current finan- the IMF’s new Flexible Credit Line should help
cial crisis—while sizable—are dwarfed by the alleviate risks for sudden stops of capital inflows
impending increases in government spending and, together with a reformed IMF condition-
on social security and health care for the elderly. ality framework, should facilitate the rapid
It is also desirable to target stimulus measures to and effective deployment of these additional
maximize the long-term benefits to the econ- resources if and when needed. For the poorest
omy’s productive potential, such as spending economies, additional donor support is crucial
on infrastructure. Importantly, to maximize the lest important gains in combating poverty and
benefits for the global economy, stimulus needs safeguarding financial stability be put at risk.
to be a joint effort among the countries with
fiscal room.
Looking further ahead, a key challenge will Medium-Run Policy Challenges
be to calibrate the pace at which the extraor- At the root of the market failure that led to
dinary monetary and fiscal stimulus now being the current crisis was optimism bred by a long
provided is withdrawn. Acting too fast would period of high growth and low real interest rates
risk undercutting what is likely to be a fragile and volatility, together with a series of policy
recovery, but acting too slowly could risk inflat- failures. These failures raise important medium-
ing new asset price bubbles or eroding cred- run challenges for policymakers. With respect
ibility. At the current juncture, the main priority to financial policies, the task is to broaden the
is to avoid reducing stimulus prematurely, perimeter of regulation and make it more flex-
while developing and articulating coherent exit ible to cover all systemically relevant institutions.
strategies. Additionally, there is a need to develop a mac-
roprudential approach to both regulation and
monetary policy. International policy coordina-
Easing External Financing Constraints tion and collaboration need to be strengthened,
Economic growth in many emerging and including by better early-warning exercises and
developing economies is falling sharply, and a more open communication of risks. Trade and
adequate external financing from official financial protectionism should be avoided, and
sources will be essential to cushion adjustment rapid completion of the Doha Round of multi-
and avoid external crises. The IMF, in concert lateral trade negotiations would revitalize global
with others, is already providing such financ- growth prospects.

Olivier Blanchard José Viñals

Economic Counsellor Financial Counsellor



The global economy is in a severe recession inflicted by mies but also for many other commodity export-
a massive financial crisis and acute loss of confidence. ers in Latin America and Africa. At the same
While the rate of contraction should moderate from time, rising economic slack has contained wage
the second quarter onward, world output is projected increases and eroded profit margins. As a result,
to decline by 1.3 percent in 2009 as a whole and to 12-month headline inflation in the advanced
recover only gradually in 2010, growing by 1.9 per- economies fell below 1 percent in February
cent. Achieving this turnaround will depend on 2009, although core inflation remained in the
stepping up efforts to heal the financial sector, while 1½–2 percent range, with the notable exception
continuing to support demand with monetary and of Japan. Inflation has also moderated signifi-
fiscal easing. cantly across the emerging economies, although
in some cases falling exchange rates have damp-
ened the downward momentum.
Recent Economic and Financial Wide-ranging and often unorthodox policy
Developments responses have made limited progress in sta-
Economies around the world have been seri- bilizing financial markets and containing the
ously affected by the financial crisis and slump downturn in output, failing to arrest corrosive
in activity. The advanced economies experi- feedback between weakening activity and intense
enced an unprecedented 7½ percent decline financial strains. Initiatives to stanch the bleed-
in real GDP during the fourth quarter of 2008, ing include public capital injections and an
and output is estimated to have continued to array of liquidity facilities, monetary easing, and
fall almost as fast during the first quarter of fiscal stimulus packages. While there have been
2009. Although the U.S. economy may have some encouraging signs of improving sentiment
suffered most from intensified financial strains since the Group of 20 (G20) meeting in early
and the continued fall in the housing sector, April, confidence in financial markets is still
western Europe and advanced Asia have been low, weighing against the prospects for an early
hit hard by the collapse in global trade, as well economic recovery.
as by rising financial problems of their own and The April 2009 Global Financial Stability Report
housing corrections in some national markets. (GFSR) estimates write-downs on U.S.-originated
Emerging economies too are suffering badly assets by all financial institutions over 2007–10
and contracted 4 percent in the fourth quarter will be $2.7 trillion, up from the estimate of
in the aggregate. The damage is being inflicted $2.2 trillion in January 2009, largely as a result
through both financial and trade channels, par- of the worsening prospects for economic
ticularly to east Asian countries that rely heavily growth. Total expected write-downs on global
on manufacturing exports and the emerging exposures are estimated at about $4 trillion,
European and Commonwealth of Independent of which two-thirds will fall on banks and the
States (CIS) economies, which have depended remainder on insurance companies, pension
on strong capital inflows to fuel growth. funds, hedge funds, and other intermediaries.
In parallel with the rapid cooling of global Across the world, banks are limiting access to
activity, inflation pressures have subsided credit (and will continue to do so) as the over-
quickly. Commodity prices fell sharply from mid- hang of bad assets and uncertainty about which
year highs, causing an especially large loss of institutions will remain solvent keep private capi-
income for the Middle Eastern and CIS econo- tal on the sidelines. Funding strains have spread


well beyond short-term bank funding markets in to decline in both 2009 and 2010. Meanwhile,
advanced economies. Many nonfinancial corpo- emerging and developing economies are
rations are unable to obtain working capital, and expected to face greatly curtailed access to
some are having difficulty raising longer-term external financing in both years. This is con-
debt. sistent with the findings in Chapter 4 that the
The broad retrenchment of foreign investors acute degree of stress in mature markets and its
and banks from emerging economies and the concentration in the banking system suggest that
resulting buildup in funding pressures are par- capital flows to emerging economies will suffer
ticularly worrisome. New securities issues have large declines and recover only slowly.
come to a virtual stop, bank-related flows have The projections also incorporate strong
been curtailed, bond spreads have soared, equity macroeconomic policy support. Monetary
prices have dropped, and exchange markets policy interest rates are expected to be low-
have come under heavy pressure. Beyond a gen- ered to or remain near the zero bound in the
eral rise in risk aversion, this reflects a range of major advanced economies, while central banks
adverse factors, including the damage done to continue to explore ways to use both the size
advanced economy banks and hedge funds, the and composition of their balance sheets to ease
desire to move funds under the “umbrella” pro- credit conditions. Fiscal deficits are expected
vided by the increasing provision of guarantees to widen sharply in both advanced and emerg-
in mature markets, and rising concerns about ing economies, as governments are assumed to
the economic prospects and vulnerabilities of implement fiscal stimulus plans in G20 countries
emerging economies. amounting to 2 percent of GDP in 2009 and
An important side effect of the financial crisis 1½ percent of GDP in 2010. The projections also
has been a flight to safety and return of home assume that commodity prices remain close to
bias, which have had an impact on the world’s current levels in 2009 and rise only modestly in
major currencies. Since September 2008, the 2010, consistent with forward market pricing.
U.S. dollar, euro, and yen have all strengthened Even with determined policy actions, and
in real effective terms. The Chinese renminbi anticipating a moderation in the rate of contrac-
and currencies pegged to the dollar (including tion from the second quarter onward, global
those in the Middle East) have also appreciated. activity is now projected to decline 1.3 percent
Most other emerging economy currencies have in 2009, a substantial downward revision from
weakened sharply, despite the use of interna- the January WEO Update. This would represent
tional reserves for support. by far the deepest post–World War II recession.
Moreover, the downturn is truly global: output
per capita is projected to decline in coun-
Outlook and Risks tries representing three-quarters of the global
The World Economic Outlook (WEO) projections economy, and growth in virtually all countries
assume that financial market stabilization will has decelerated sharply from rates observed in
take longer than previously envisaged, even with 2003–07. Growth is projected to reemerge in
strong efforts by policymakers. Thus, financial 2010, but at just 1.9 percent would be sluggish
strains in the mature markets are projected to relative to past recoveries, consistent with the
remain heavy until well into 2010, improving findings in Chapter 3 that recoveries after finan-
only slowly as greater clarity over losses on bad cial crises are significantly slower than other
assets and injections of public capital reduce recoveries.
insolvency concerns, lower counterparty risks The current outlook is exceptionally uncer-
and market volatility, and restore more liquid tain, with risks weighed to the downside. The
market conditions. Overall credit to the private dominant concern is that policies will continue
sector in the advanced economies is expected to be insufficient to arrest the negative feedback


between deteriorating financial conditions and flows—will help support global demand, with
weakening economies, particularly in the face shared benefits. Conversely, a slide toward trade
of limited public support for policy action. Key and financial protectionism would be hugely
transmission channels include rising corporate damaging to all, a clear warning from the expe-
and household defaults that cause further falls rience of 1930s beggar-thy-neighbor policies.
in asset prices and greater losses across financial
balance sheets, and new systemic events that
further complicate the task of restoring credibil-
ity. Furthermore, in a highly uncertain context,
Advancing Financial Sector Restructuring
fiscal and monetary policies may fail to gain The greatest policy priority at this juncture
traction, since high rates of precautionary saving is financial sector restructuring. Convincing
could lower fiscal multipliers, and steps to ease progress on this front is the sine qua non for an
funding could fail to slow the pace of dele- economic recovery to take hold and would sig-
veraging. On the upside, however, bold policy nificantly enhance the effectiveness of monetary
implementation that is able to convince mar- and fiscal stimulus. In the short run, the three
kets that financial strains are being dealt with priorities identified in previous GFSRs remain
decisively could revive confidence and spending appropriate: (1) ensuring that financial institu-
commitments. tions have access to liquidity, (2) identifying and
Even once the crisis is over, there will be a dealing with distressed assets, and (3) recapital-
difficult transition period, with output growth izing weak but viable institutions. The first area
appreciably below rates seen in the recent past. is being addressed forcefully. Policy initiatives in
Financial leverage will need to be reduced, the other two areas, however, need to advance
implying lower credit growth and scarcer financ- more convincingly.
ing than in recent years, especially in emerging The critical underpinning of an enduring
and developing economies. In addition, large solution must be credible loss recognition on
fiscal deficits will need to be rolled back just as impaired assets. To that effect, governments
population aging accelerates in a number of need to establish common basic methodologies
advanced economies. Moreover, in key advanced for the realistic valuation of securitized credit
economies, households will likely continue to instruments, which should be based on expected
rebuild savings for some time. All this will weigh economic conditions and an attempt to esti-
on both actual and potential growth over the mate the value of future income streams. Steps
medium run. will also be needed to reduce considerably the
uncertainty related to further losses from these
exposures. Various approaches to dealing with
Policy Challenges bad assets in banks can work, provided they are
This difficult and uncertain outlook argues supported with adequate funding and imple-
for forceful action on both the financial and mented in a transparent manner.
macroeconomic policy fronts. Past episodes Recapitalization methods must be rooted in
of financial crisis have shown that delays in a careful evaluation of the long-term viability of
tackling the underlying problem mean an even institutions, taking into account both losses to
more protracted economic downturn and even date and a realistic assessment of the prospects
greater costs, both in terms of taxpayer money of further write-downs. Subject to a number
and economic activity. Policymakers must be of assumptions, GFSR estimates suggest that
mindful of the cross-border ramifications of the amount of capital needed might amount
policy choices. Initiatives that support trade and to $275 billion–$500 billion for U.S. banks,
financial partners—including fiscal stimulus $475 billion–$950 billion for European banks
and official support for international financing (excluding those in the United Kingdom), and


$125 billion–$250 billion for U.K. banks.1 As large-scale restructuring in case circumstances
supervisors assess recapitalization needs on a deteriorate further.
bank-by-bank basis, they will need assurance Greater international cooperation is needed to
of the quality of banks’ capital; the robust- avoid exacerbating cross-border strains. Coordi-
ness of their funding, business plans, and risk nation and collaboration is particularly impor-
management processes; the appropriateness tant with respect to financial policies to avoid
of compensation policies; and the strength of adverse international spillovers from national
management. Supervisors will also need to estab- actions. At the same time, international sup-
lish the appropriate level of regulatory capital port, including from the IMF, can help countries
for institutions, taking into account regulatory buffer the impact of the financial crisis on real
minimums and the need for buffers to absorb activity and, particularly in the developing coun-
further unexpected losses. Viable banks that tries, limit its effects on poverty. Recent reforms
have insufficient capital should be quickly to increase the flexibility of lending instruments
for good performers caught in bad weather,
recapitalized, with capital injections from the
together with plans advanced by the G20 summit
government (if possible, accompanied by private
to increase the resources available to the IMF,
capital) to bring capital ratios to a level suffi-
are enhancing the capacity of the international
cient to regain market confidence. Authorities
financial community to address risks related to
should be prepared to provide capital in the
sudden stops of private capital flows.
form of common shares in order to improve
confidence and funding prospects and this may
entail a temporary period of public ownership Easing Monetary Policy
until a private sector solution can be developed.
In advanced economies, scope for easing
Nonviable financial institutions need to be inter- monetary policy further should be used aggres-
vened promptly, leading to resolution through sively to counter deflation risks. Although
closures or mergers. Amounts of public funding policy rates are already near the zero floor in
needed are likely to be large, but requirements many countries, whatever policy room remains
are likely to rise the longer it takes for a solution should be used quickly. At the same time, a clear
to be implemented. communication strategy is important—central
Wide-ranging efforts to deal with financial bankers should underline their determination to
strains will also be needed in emerging econo- avoid deflation by sustaining easy monetary con-
mies. The corporate sector is at considerable ditions for as long as necessary. In an increasing
risk. Direct government support for corporate number of cases, lower interest rates will need
borrowing may be warranted. Some countries to be supported by increasing recourse to less
have also extended their guarantees of bank conventional measures, using both the size and
debt to firms, focusing on those associated with composition of the central bank’s own balance
export markets, or have provided backstops to sheet to support credit intermediation. To the
trade finance through various facilities—help- extent possible, such actions should be struc-
ing to keep trade flowing and limiting damage tured to maximize relief in dislocated markets
to the real economy. In addition, contingency while leaving credit allocation decisions to the
plans should be devised to prepare for potential private sector and protecting the central bank
balance sheet from credit risk.
1The lower end of the range corresponds to capital Emerging economies also need to ease mon-
needed to adjust leverage, measured as tangible common etary conditions to respond to the deteriorating
equity (TCE) over total assets, to 4 percent. The upper outlook. However, in many of those economies,
end corresponds to capital needed to raise the TCE ratio
to 6 percent, consistent with levels observed in the mid- the task of central banks is further complicated
1990s (see the April 2009 GFSR). by the need to sustain external stability in the


face of highly fragile financing flows. To a to support the recovery. As far as possible, this
much greater extent than in advanced econo- should be a joint effort, since part of the impact
mies, emerging market financing is subject of an individual country’s measures will leak
to dramatic disruptions—sudden stops—in across borders, but brings benefits to the global
part because of much greater concerns about economy.
the creditworthiness of the sovereign. Emerg- How can the tension between stimulus and
ing economies also have tended to borrow sustainability be alleviated? One key is the
more heavily in foreign currency, and so large choice of stimulus measures. As far as pos-
exchange rate depreciations can severely dam- sible, these should be temporary and maximize
age balance sheets. Thus, while most central “bang for the buck” (for example, acceler-
banks in these economies have lowered interest ated spending on already planned or existing
rates in the face of the global downturn, they projects and time-bound tax cuts for credit-
have been appropriately cautious in doing so to constrained households). It is also desirable to
maintain incentives for capital inflows and to target measures that bring long-term benefits
avoid disorderly exchange rate moves. to the economy’s productive potential, such as
Looking further ahead, a key challenge will spending on infrastructure. Second, govern-
be to calibrate the pace at which the extraor-
ments need to complement initiatives to provide
dinary monetary stimulus now being provided
short-term stimulus with reforms to strengthen
should be withdrawn. Acting too fast would risk
medium-term fiscal frameworks to provide reas-
undercutting what is likely to be a fragile recov-
surance that short-term deficits will be reversed
ery, but acting too slowly could risk overheating
and public debt contained. Third, a key element
and inflating new asset price bubbles.
to ensure fiscal sustainability in many countries
would be concrete progress toward dealing with
Combining Fiscal Stimulus with Sustainability the fiscal challenges posed by aging populations.
The costs of the current financial crisis—while
In view of the extent of the downturn and the
sizable—are dwarfed by the impending costs
limits to the effectiveness of monetary policy,
from rising expenditures on social security
fiscal policy must play a crucial part in providing
and health care for the elderly. Credible policy
short-term stimulus to the global economy. Past
experience suggests that fiscal policy is particu- reforms to these programs may not have much
larly effective in shortening the duration of immediate impact on fiscal accounts but could
recessions caused by financial crises (Chapter 3). make an enormous change to fiscal prospects,
However, the room to provide fiscal support will and thus could help preserve fiscal room to
be limited if efforts erode credibility. Thus, gov- provide short-term fiscal support.
ernments are faced with a difficult balancing act,
delivering short-term expansionary policies but
Medium-Run Policy Challenges
also providing reassurance about medium-term
prospects. Fiscal consolidation will be needed At the root of the market failure that led to
once a recovery has taken hold, and this can be the current crisis was optimism bred by a long
facilitated by strong medium-term fiscal frame- period of high growth and low real interest rates
works. However, consolidation should not be and volatility, along with policy failures. Finan-
launched prematurely. While governments have cial regulation was not equipped to address the
acted to provide substantial stimulus in 2009, it risk concentrations and flawed incentives behind
is now apparent that the effort will need to be the financial innovation boom. Macroeconomic
at least sustained, if not increased, in 2010, and policies did not take into account the buildup
countries with fiscal room should stand ready of systemic risks in the financial system and in
to introduce new stimulus measures as needed housing markets.


This raises important medium-run challenges account asset price movements, credit booms,
for policymakers. With respect to financial leverage, and the buildup of systemic risk. Fiscal
policies, the task now is to broaden the perim- policymakers will need to bring down deficits
eter of regulation and make it more flexible to and put public debt on a sustainable trajectory.
cover all systemically relevant institutions. In International policy coordination and col-
addition, there is a need to develop a mac- laboration need to be strengthened, based on
roprudential approach to regulation, which better early-warning systems and a more open
would include compensation structures that communication of risks. Cooperation is particu-
mitigate procyclical effects, robust market- larly pressing for financial policies, because of
clearing arrangements, accounting rules to the major spillovers that domestic actions can
accommodate illiquid securities, transparency have on other countries. At the same time, rapid
about the nature and location of risks to foster completion of the Doha Round of multilateral
market discipline, and better systemic liquidity trade talks could revitalize global growth pros-
management. pects, while strong support from bilateral and
Regarding macroeconomic policies, central multilateral sources, including the IMF, could
banks should also adopt a broader macropru- help limit the adverse economic and social fall-
dential view, paying due attention to financial out of the financial crisis in many emerging and
stability as well as price stability by taking into developing economies.



The global economy is in a severe recession inflicted Figure 1.1. Global Indicators1
by a massive financial crisis and an acute loss of (Annual percent change unless otherwise noted)
confidence. Wide-ranging and often unorthodox policy
The global economy is undergoing its most severe recession of the postwar period.
responses have made some progress in stabilizing World real GDP will drop in 2009, with advanced economies experiencing deep
contractions and emerging and developing economies slowing abruptly. Trade
financial markets but have not yet restored confidence volumes are falling sharply, while inflation is subsiding quickly.
nor arrested negative feedback between weakening
activity and intense financial strains. While the 8 World Real GDP Growth Real GDP Growth 10
Emerging and
rate of contraction is expected to moderate from the developing economies 8
6 Trend,
second quarter onward, global activity is projected to 6
decline by 1.3 percent in 2009 as a whole before rising 4

modestly during the course of 2010 (Figure 1.1). This 2 2

turnaround depends on financial authorities acting 0
decisively to restore financial stability and fiscal and Advanced -2
monetary policies in the world’s major economies pro- -2 -4
1970 80 90 2000 10 1970 80 90 2000 10
viding sustained strong support for aggregate demand.
20 Consumer Prices Real Commodity Prices 500
Emerging and (1995 = 100)

his chapter opens by exploring how developing economies
15 (median) 400
a dramatic escalation of the financial
crisis in September 2008 has provoked 10 Oil prices3 300
an unprecedented contraction of Food
5 200
activity and trade, despite policy efforts. It then Advanced
discusses the projections for 2009 and 2010, 0 100
emphasizing the key role that must be played
-5 0
by policies to promote a durable recovery and 1970 80 90 2000 10 1980 85 90 95 2000 05 10

the downside risks if feedback between the real

16 World Trade Volume Contribution to Global GDP 8
and financial sectors continues to intensify. The (goods and services) Growth, PPP Basis (percent,
12 Trend, three-year moving averages) 6
third section looks beyond the current crisis, 1970–20082
considering factors that will shape the landscape 4
of the global economy over the medium term, 2
as businesses and households seek to repair the
damage. The final part of the chapter reviews -4
Rest of the world
China -2
the difficult policy challenges at the current -8 United States
Other advanced economies
juncture, stressing that while the overwhelm- -12 -4
1970 80 90 2000 10 1970 80 90 2000 10
ing imperative is to take all steps necessary to
Source: IMF staff estimates.
restore financial stability and revive the global 1Shaded areas indicate IMF staff projections. Aggregates are computed on the basis of
purchasing-power-parity (PPP) weights unless otherwise noted.
economy, policymakers must also be mindful of 2Average growth rates for individual countries, aggregated using PPP weights; aggre-
gates shift over time in favor of faster-growing economies, giving the line an upward trend.
longer-run challenges and the need for national 3Simple average of spot prices of U.K. Brent, Dubai Fateh, and West Texas Intermediate

actions to be mutually supportive. crude oil.


Figure 1.2. Developments in Mature Credit Markets How Did Things Get So Bad, So Fast?
In the year following the outbreak of the
Conditions in mature credit markets deteriorated sharply after September 2008, and
strains remain intense despite policy efforts and some improvements in market U.S. subprime crisis in August 2007, the global
sentiment following the G20 meeting in early April. While interbank spreads have
been lowered, bank CDS spreads and corporate spreads have remained wide, and
economy bent but did not buckle. Activity
equity prices are close to multiyear lows, as adverse linkages between the financial slowed in the face of tightening credit condi-
sector and the real economy have intensified.
tions, with advanced economies falling into
500 Interbank Spreads1
mild recessions by the middle quarters of 2008,
Bank CDS Spreads 2 400
(basis points) (ten-year; median; in basis but with emerging and developing economies
400 points)
continuing to grow at fairly robust rates by past
standards. However, financial wounds continued
dollar to fester, despite policymakers’ efforts to sustain
200 200
market liquidity and capitalization, as concerns
100 Euro
area about losses from bad assets increasingly raised
0 questions about the solvency and funding of
Yen core financial institutions.
-100 0
2000 02 04 06 Apr. 2003 04 05 06 07 Apr. The situation deteriorated rapidly after the
09 09
dramatic blowout of the financial crisis in
6 Government Bonds 700 Corporate Spreads 1800 September 2008, following the default by a
(basis points)
United 1600 large U.S. investment bank (Lehman Broth-
5 States 600 Europe BB
(right scale) 1400
500 United States BB
ers), the rescue of the largest U.S. insurance
4 (right scale) 1200
company (American International Group, AIG),
400 1000
United States
3 Euro area AAA and intervention in a range of other systemic
300 800
(left scale) institutions in the United States and Europe.
2 Europe AAA 600
(left scale) 400 These events prompted a huge increase in
1 Japan 100 200 perceived counterparty risk as banks faced large
0 0 0 write-downs, the solvency of many of the most
2002 04 06 Apr. 2000 02 04 06 Apr.
09 09 established financial names came into ques-
tion, the demand for liquidity jumped to new
100 Bank Lending Conditions 4 -15 Equity Markets 120
(March 2000 = 100; national heights, and market volatility surged once more.
80 Euro area -10 currency) 110
(left scale) 100
The result was a flight to quality that depressed
60 (inverted; -5 yields on the most liquid government securi-
Wilshire 90
right scale)
40 0 5000 ties and an evaporation of wholesale funding
20 5 70 that prompted a disorderly deleveraging that
10 DJ Euro
60 cascaded across the rest of the global financial
(left scale) Stoxx 50 system (Figure 1.2). Liquid assets were sold at
-20 15 Topix
40 fire-sale prices, and credit lines to hedge funds
-40 20 30
2000 02 04 06 09: 2000 02 04 06 Apr. and other leveraged financial intermediaries
Q1 09
in the so-called shadow banking system were
Sources: Bank of Japan; Bloomberg Financial Markets; Federal Reserve Board of slashed. High-grade as well as high-yield corpo-
Governors; European Central Bank; Merrill Lynch; and IMF staff calculations.
1Three-month London interbank offered rate minus three-month government bill rate. rate bond spreads widened sharply, the flow of
2CDS = credit default swap.
3 Ten-year government bonds. trade finance and working capital was heavily
4 Percent of respondents describing lending standards as tightening “considerably” or disrupted, banks tightened lending standards
“somewhat” minus those indicating standards as easing “considerably” or “somewhat”
over the previous three months. Survey of changes to credit standards for loans or lines of further, and equity prices fell steeply.
credit to enterprises for the euro area; average of surveys on changes in credit standards Emerging markets—which earlier had been
for commercial/industrial and commercial real estate lending for the United States;
Diffusion index of “accommodative” minus “severe,” Tankan lending attitude of financial relatively sheltered from financial strains by their
institutions survey for Japan.
limited exposure to the U.S. subprime market—


have been hit hard by these events. New securi-

ties issues came to a virtual stop, bank-related Figure 1.3. Emerging Market Conditions
flows were curtailed, bond spreads soared,
equity prices dropped, and exchange markets Emerging markets were hard hit by the escalation of the financial crisis. Equity prices
came under heavy pressure (Figure 1.3). Beyond plummeted, spreads widened sharply, and new securities issues were curtailed.
Policy rates were lowered in response to weakening economic prospects, although
a general rise in risk aversion, capital flows have less aggressively than in mature markets in view of concerns about presure on the
been curtailed by a range of adverse factors, external accounts from a reversal in capital flows.

including the damage done to banks (especially

in western Europe) and hedge funds, which
600 Equity Markets Interest Rate Spreads 1600
had previously been major conduits; the desire (2001 = 100; (basis points)
national currency)
to move funds under the “umbrella” offered by 500 United States
BB 1200
the increasing provision of guarantees in mature 400 Latin
markets; and rising concerns about national eco- America
300 800
nomic prospects, particularly in economies that Eastern Sovereign1
previously had relied extensively on external 200 Asia Corporate 2
financing. Adding to the strains, the turbulence
exposed internal vulnerabilities within many AAA

emerging economies, bringing attention to cur- 0 0

2002 03 04 05 06 07 Apr. 2002 03 04 05 06 07 Apr.
09 09
rency mismatches on borrower balance sheets,
weak risk management (for example, substantial 3 Private Credit Growth
250 New Issues 40
corporate losses on currency derivatives markets (billions of U.S. dollars) (twelve-month percent change)
in some countries), and excessively rapid bank 200 Western Hemisphere 32
Middle East Eastern
credit growth. 175 Europe
Asia Europe 24
Although a global meltdown was averted 150 Africa
by determined fire-fighting efforts, this sharp 125 16
escalation of financial stress battered the global 8
75 Latin
economy through a range of channels. The 50 America
credit crunch generated by deleveraging pres- 25
sures and a breakdown of securitization technol- 0 -8
2002 03 04 05 06 07 08 09: 2002 03 04 05 06 07 Feb.
ogy has hurt even the most highly rated private Q1 09

borrowers. Sharp falls in equity markets as well

20 Nominal Policy Rates Real Policy Rates 4 8
as continuing deflation of housing bubbles (percent) (percent)
have led to a massive loss of household wealth. Latin
16 6
In part, these developments reflected the Latin America
inevitable adjustments to correct past excesses 12 4
and technological failures akin to those that Eastern
8 Europe 2
triggered the bursting of the dot-com bubble.
However, because the excesses and failures were Asia
4 0
at the core of the banking system, the ramifica- Eastern
tions have been quickly transmitted to all sectors 0 -2
2003 04 05 06 07 Mar. 2003 04 05 06 07 Feb.
and countries of the global economy. Moreover, 09 09
the scale of the blows has been greatly magni-
fied by the collapse of business and consumer Sources: Bloomberg Financial Markets; Capital Data; IMF, International Financial
Statistics; and IMF staff calculations.
confidence in the face of rising doubts about 1JPMorgan EMBI Global Index spread.
2 JPMorgan CEMBI Broad Index spread.
economic prospects and continuing uncertainty 3 Total of equity, syndicated loans, and international bond issuances.
4 Relative to headline inflation.
about policy responses. The rapidly deterio-
rating economic outlook further accentuated


Figure 1.4. Current and Forward-Looking Indicators financial strains in a corrosive global feedback
(Percent change from a year earlier unless otherwise noted) loop that has undermined policymakers’ efforts
to remedy the situation.
Industrial production, trade, and employment have dropped sharply since the Thus, the impact on activity was felt quickly
blowout in the financial crisis in September 2008. Recent data on business
confidence and retail sales provide some tentative signs that the rate of contraction and broadly. Industrial production and mer-
of the global economy may now be moderating. chandise trade plummeted in the fourth
quarter of 2008 and continued to fall rapidly in
15 Industrial Production World Trade 30
Emerging early 2009 across both advanced and emerg-
economies1 Trade value 3
10 20 ing economies, as purchases of investment
goods and consumer durables such as autos
0 and electronics were hit by credit disruptions
CPB trade
-5 World volume index and rising anxiety and inventories started to
Advanced -10 build rapidly (Figure 1.4). Recent data provide
-10 economies 2
some tentative indications that the rate of
-15 -20
contraction may now be starting to moderate.
-20 -30 Business confidence has picked up modestly,
2000 02 04 06 Feb. 2000 02 04 06 Jan.
09 09 and there are signs that consumer purchases
are stabilizing, helped by the cushion provided
4 Employment Retail Sales 20
by falling commodity prices and anticipation
Emerging 16
Euro area of macroeconomic policy support. However,
2 economies1
12 employment continues to drop fast, notably in
World 8 the United States.
Japan 4 Overall, global GDP is estimated to have con-
tracted by an alarming 6¼ percent (annualized)
in the fourth quarter of 2008 (a swing from
United States Advanced -4
economies2 4 percent growth one year earlier) and to have
-4 -8 fallen almost as fast in the first quarter of 2009.
2000 02 04 06 Mar. 2000 02 04 06 Feb.
09 09 All economies around the world have been
seriously affected, although the direction of the
Manufacturing Purchasing Consumer Confidence
65 Managers Index 180 (index) 5 blows has varied, as explored in more detail
(index) Emerging
60 economies1 160 0 in Chapter 2. The advanced economies expe-
Euro area
140 (right scale) -5 rienced an unprecedented 7½ percent decline
120 -10 in the fourth quarter of 2008, and most are
100 -15 now suffering deep recessions. While the U.S.
80 United States -20 economy may have suffered particularly from
40 economies2 60 Japan4 (left scale)
-25 intensified financial strains and the continued
(left scale)
35 40 -30 fall in the housing sector, western Europe and
30 20 -35 advanced Asia have been hit hard by the col-
2000 02 04 06 Mar. 2000 02 04 06 Mar.
09 09 lapse in trade as well as rising financial prob-
lems of their own and housing corrections in
Sources: CPB Netherlands Bureau for Economic Policy Analysis for CPB trade volume some national markets.
index; for all others, NTC Economics and Haver Analytics.
1Argentina, Brazil, Bulgaria, Chile, China, Colombia, Estonia, Hungary, India, Indonesia, Emerging economies too have suffered badly
Latvia, Lithuania, Malaysia, Mexico, Pakistan, Peru, Philippines, Poland, Romania, Russia,
Slovak Republic, South Africa, Thailand, Turkey, Ukraine, and Venezuela. and contracted 4 percent in the fourth quar-
2 Australia, Canada, Czech Republic, Denmark, euro area, Hong Kong SAR, Israel, Japan,
ter in the aggregate. The damage has been
Korea, New Zealand, Norway, Singapore, Sweden, Switzerland, Taiwan Province of China,
United Kingdom, and United States. inflicted through both financial and trade
3 Percent change from a year earlier in SDR terms.
4 Japan’s consumer confidence data are based on a diffusion index, where values greater channels. Activity in east Asian economies with
than 50 indicate improving confidence. heavy reliance on manufacturing exports has


fallen sharply, although the downturns in China Figure 1.5. Global Inflation
and India have been somewhat muted given the (Twelve-month change in the consumer price index unless otherwise
lower shares of their export sectors in domes- noted)
tic production and more resilient domestic
demand. Emerging Europe and the Common- Inflation pressures have subsided quickly, as output gaps have widened and food and
fuel prices have dropped. One-year inflation expectations and core inflation have
wealth of Independent States (CIS) have been declined below central bank inflation objectives in major advanced economies.
hit very hard because of heavy dependence on
external financing as well as on manufacturing Global Aggregates
exports and, for the CIS, commodity exports. 10 Headline Inflation Core Inflation 10
Countries in Africa, Latin America, and the Emerging
8 8
Middle East have suffered from plummeting economies World
commodity prices as well as financial strains 6 Emerging 6
Advanced economies
and weak export demand. 4 economies 4
In parallel with the rapid cooling of global
2 2
activity, inflation pressures have subsided Advanced
quickly (Figure 1.5). Commodity prices fell 0
2002 03 04 05 06 07 Feb. 2002 03 04 05 06 07
sharply from mid-year highs, undercut by the 09 09
weakening prospects for the emerging econo- 16 Food Price Inflation Fuel Price Inflation 24
mies that have provided the bulk of demand World 18
growth in recent years (Appendix 1.1). At the Emerging
economies 12
same time, rising economic slack has contained 8
wage increases and eroded profit margins. As 4
a result, 12-month headline inflation in the Advanced
0 Emerging
Advanced -6
advanced economies fell below 1 percent in Feb- World economies
ruary 2009, although core inflation remained in -4
2002 03 04 05 06 07 Jan. 2002 03 04 05 06 07
the 1½–2 percent range with the notable excep- 09 09

tion of Japan. Inflation has also moderated Country Indicators

significantly across the emerging economies, 5 Advanced Economies: Headline Advanced Economies: Core 5
Inflation United States1 Inflation
although in some cases falling exchange rates 4 4
have moderated the downward momentum. 3 United States1 3
One side effect of the financial crisis has 2
Euro area
been a flight to safety and rising home bias. 1 Euro area 1
Gross global capital flows contracted sharply in 0 0
-1 Japan Japan -1
the fourth quarter of 2008. In net terms, flows
have favored countries with the most liquid -2 -2
2002 03 04 05 06 07 Feb. 2002 03 04 05 06 07 Feb.
and safe government securities markets, and 09 09

net private flows to emerging and developing 4 Advanced Economies: Inflation Emerging Economies: Headline 25
Expectations2 Inflation
economies have collapsed. These shifts have 3 United States 20
affected the world’s major currencies. Since 15
2 Russia
September 2008, the euro, U.S. dollar, and yen Euro area 10
have appreciated notably (Figure 1.6). The Chi- 1 Japan
nese renminbi and other currencies pegged to India
0 0
the dollar (including those in the Middle East) China
have also appreciated in real effective terms. -1 -5
2002 03 04 05 06 07 Mar. 2002 03 04 05 06 07 Mar.
09 09
Most other emerging economy currencies have
Sources: Bloomberg Financial Markets; Haver Analytics; and IMF staff calculations.
weakened sharply, despite use of international 1Personal consumption expenditure deflator.
reserves for support. 2One-year-ahead consensus forecasts.


Figure 1.6. External Developments Policies Fail to Gain Traction

(Index, 2000 = 100, three-month moving average, unless otherwise noted) Policy responses to these developments
have been rapid, wide-ranging, and frequently
A flight to safety since September 2008 has led to significant real effective
appreciations of the major global currencies. The renminbi and other currencies
unorthodox, but were too often piecemeal and
closely linked to the U.S. dollar have also appreciated in real effective terms, but have failed to arrest the downward spiral. Fol-
currencies of other emerging and developing economies have weakened considerably,
as private capital account flows have reversed, despite official intervention.
lowing the heavy fallout from the collapse of
Lehman Brothers, authorities in major mature
Major Currencies markets made clear that no other potentially
150 Nominal Effective Exchange Real Effective Exchange Rate 140 systemic financial institution would be allowed
140 Euro area to fail. A number of major banks in the United
Euro area
130 120 States and Europe were provided with public
120 China support in the form of new capital and guar-
100 antees against losses from holdings of problem
100 assets. More broadly, authorities have followed
90 States 80 multifaceted strategies involving continued
80 Japan provision of liquidity and extended guarantees
United States
70 60 of bank liabilities to alleviate funding pressures,
2000 02 04 06 Mar. 2000 02 04 06 Mar.
09 09 making available public funds for bank recapi-
talization, and announcing programs to deal
Emerging and Developing Economies
with distressed assets. However, policy announce-
120 Nominal Effective Exchange Real Effective Exchange Rate 150
Rate Emerging ments have often been short on detail and have
110 Middle Europe4 not convinced markets; cross-border coordina-
East 1 Africa2 130
100 tion of initiatives has been lacking, resulting in
Africa2 120
undesirable spillovers; and progress in alleviat-
90 Asia3 110
Latin ing uncertainty related to distressed assets has
America5 100
80 Asia3 been limited.
At the same time, with inflation concerns
Emerging Latin Middle1 80
Europe4 America5 East dwindling and risks to the outlook deepening,
60 70
2000 02 04 06 Mar. 2000 02 04 06 Mar. central banks have used a range of conventional
09 09
and unconventional policy tools to support the
28 Current Account Positions International Reserves 1000 economy and ease credit market conditions. Pol-
(percent of GDP) 900
24 Asia icy rates have been cut sharply, bringing them
Middle 800
20 to ½ percent or less in some countries (Canada,
East 1 Middle
16 East 1 700
Japan, United Kingdom, United States) and to
12 600
unprecedented lows in other cases (including
8 Asia Europe4
America 400 the euro area and Sweden) (Figure 1.7). How-
4 Latin America
300 ever, the impact of rate cuts has been limited by
Emerging Europe 4 200 credit market disruptions, and the zero bound
100 has constrained central bankers’ ability to add
2000 02 04 06 08 2000 02 04 06 Feb.
09 further stimulus. Some central banks (notably,
Sources: IMF, International Financial Statistics; and IMF staff calculations.
in Japan, United Kingdom, United States) have
1Bahrain, Egypt, I.R. of Iran, Jordan, Kuwait, Lebanon, Libya, Oman, Qatar, Saudi Arabia, therefore increased purchases of long-term gov-
Syrian Arab Republic, United Arab Emirates, and Republic of Yemen.
2 Botswana, Burkina Faso, Cameroon, Chad, Republic of Congo, Côte d'Ivoire, Djibouti, ernment securities and provided direct support
Equatorial Guinea, Ethiopia, Gabon, Ghana, Guinea, Kenya, Madagascar, Mali, Mauritius, to illiquid credit markets by providing funding
Mozambique, Namibia, Niger, Nigeria, Rwanda, Senegal, South Africa, Sudan, Tanzania,
Uganda, and Zambia. and guarantees to intermediaries in targeted
3 Asia excluding China.
4 Bulgaria, Croatia, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, and Turkey. markets, with some success in bringing down
5 Argentina, Brazil, Chile, Colombia, Mexico, Peru, and Venezuela.
spreads in specific market segments such as the


U.S. commercial paper and residential mort- Figure 1.7. Measures of Monetary Policy and Liquidity
gage-backed securities markets. As a result, cen- in Selected Advanced Economies
tral bank balance sheets have expanded rapidly (Interest rates in percent unless otherwise noted)
as central banks have become major intermedi-
Policy rates in the major advanced economies have been lowered rapidly as inflation
aries in the credit process. Nevertheless, overall pressures have subsided and economic prospects have deteriorated. With policy
credit growth to the private sector has dropped rates approaching the zero floor, central banks have increasingly taken steps to
support credit creation more directly, leading to the rapid expansion of their balance
sharply, reflecting a combination of tighter bank sheets. Despite these efforts, credit growth to the private sector has slowed sharply.
lending standards, securities market disruptions,
and lower credit demand as economic prospects 7 Nominal Short-Term Interest Real Short-Term Interest Rates 2 4
Rates 1
have darkened. 6 United 3
As concerns about the extent of the downturn States
5 Euro area 2
and the limits to monetary policy have mounted, Euro
governments have also turned to fiscal policy to area
support demand. Beyond letting automatic stabi- Japan
lizers work, large discretionary stimulus pack- 2

ages have been introduced in most advanced 1 United States -1

economies, notably Germany, Japan, Korea, 0 -2
2000 02 04 06 Apr. 2000 02 04 06 Feb.
the United Kingdom, and the United States. 09 09
Although the impact of the downturn and
2 Deviation from Taylor Rule 3 Central Banks Total Assets 400
stimulus will be felt mainly in 2009 and 2010, (index, Jan. 5, 2007 = 100)
Japan 350
fiscal deficits in the major advanced economies United Kingdom
rose by more than 2 percentage points in 2008, 0
after several years of consolidation (Table A8). United States
Euro area 250
Government debt levels are also being boosted -2
by public support to the banking system, and Euro area
United 150
some countries’ room for fiscal action has been -4
reduced by upward pressure on government Japan
bond yields as concerns about long-term fiscal -6 50
2000 02 04 06 09: 2007 08 Apr.
sustainability have risen. Q1 09

Policy responses in the emerging and develop- 2500 Credit Growth in Private 250 Quantitative Liquidity Measures5 12
ing economies to weakening activity and rising Sectors 4 (percent of G3 GDP)
2000 United States 200 10
external pressures have varied considerably, Base money
(left scale) plus reserves 8
depending on circumstances. Many countries, 1500 150
especially in Asia and Latin America, have been Reserves 6
1000 100
able to use policy buffers to alleviate pressures, 4
letting exchange rates adjust downward but 500 50
Base 2
Euro area money
also applying reserves to counter disorderly 0 0 0
(right scale)
market conditions and to augment private
-500 -50 -2
credit, including in particular to sustain trade 2000 02 04 06 08: 2000 02 04 06 08:
Q4 Q4
finance. Dollar swap facilities offered by the
Federal Reserve to a number of systemically Sources: Bloomberg Financial Markets; Eurostat; Haver Analytics; Merrill Lynch; OECD
Economic Outlook; and IMF staff calculations.
important countries as well as the introduc- 1 Three-month treasury bills.
2 Relative to core inflation.
tion of a more flexible credit instument by the 3 The Taylor rate depends on (1) the neutral real rate of interest, which in turn is a
IMF provided some assurance to markets that function of potential output growth; (2) the deviation of expected consumer price inflation
from the inflation target; and (3) the output gap. Expected inflation is derived from
countries with sound management would have one-year-ahead consensus forecasts.
4 Quarter-over-quarter changes; in billions of local currency.
access to needed external funding and not be 5 Change over three years for euro area, Japan, and United States (G3), denominated in
faced with a capital account crisis. Moreover, U.S. dollars.


many central banks changed course to lower markets remain deeply impaired. The situation
policy interest rates to ease domestic conditions is further complicated by continuing uncer-
(see Figure 1.3), as earlier inflation concerns tainty—both about economic prospects and the
moderated. Governments have also provided valuation of bad assets—particularly since little
fiscal support through automatic stabilizers and progress has been made in either reestablishing
discretionary measures, albeit typically on a liquid markets in these assets or reducing bank
much smaller scale than in the advanced econo- exposure to fluctuations in their value.
mies, with the notable exceptions of China and The continued pressures reflect to an impor-
Saudi Arabia. They have had room to maneuver tant degree the damaging feedback loop with
because of their reserve stockpiles, more cred- the real economy—as economic prospects have
ible inflation-targeting regimes, and stronger darkened, estimates of financial losses have con-
public balance sheets. tinued to rise, so that markets have continued
Elsewhere, however, especially in emerging to question bank solvency despite substantial
Europe and the CIS, greater internal vulnerabili- infusions of public resources. The GFSR esti-
ties, and in some cases less flexible exchange mates that expected write-downs on U.S.–based
rate regimes, have complicated the policy assets suffered by all financial institutions over
response. A number of countries that face severe 2007–10 will amount to $2.7 trillion (up from
external financing shortages, fragile banking the estimate of $2.2 trillion in January 2009).
systems, currency mismatches on borrower bal- Total expected write-downs on global exposures
ance sheets, and rising questions about public are estimated at $4 trillion, of which about two-
finances have acted to tighten macroeconomic thirds will fall on banks, with the remainder dis-
policies and received external financial support tributed among insurance companies, pension
from the IMF and other official sources. How- funds, hedge funds, and other intermediaries,
ever, stabilization has been elusive as the exter- although this figure is subject to a substantial
nal environment has continued to deteriorate. margin of error. So far, banks have recognized
less than one-third of estimated losses, and
substantial amounts of new capital are needed.
The Financial Hole Has Become Even Deeper Subject to a number of assumptions, the GFSR
The policy responses in both advanced and estimates that additional capital would be
emerging economies have helped alleviate the required (measured as tangible common equity)
extreme financial market disruptions observed amounting to $275 billion–$500 billion in the
in October–November 2008, and there have United States, $475 billion–$950 billion for
been encouraging signs of improving sentiment European banks (excluding those in the United
since the G20 meeting in early April, but finan- Kingdom), and $125 billion–$250 billion for
cial market conditions have generally remained U.K. banks.1 Moreover, insurance company and
highly stressed. Thus, financial risks have risen pension fund balance sheets have been badly
further along most dimensions, as discussed in damaged as their assets have declined in value,
detail in the April 2009 Global Financial Stability and lower government bond yields used to
Report (GFSR). Most market risk and volatility discount liabilities have simultaneously widened
indicators are still well above ranges observed asset-liability mismatches.
before September 2008, let alone before August
2007 (see Figures 1.2 and 1.3). Although access
for high-grade borrowers in securities markets 1The lower end of the range corresponds to capital

has improved, bank credit growth is falling rap- needed to adjust leverage, measured as tangible common
idly across the board, bank wholesale funding equity (TCE) over total assets (TA), to 4 percent. The
upper end corresponds to capital needed to lower lever-
in mature markets remains highly dependent age to levels observed in the mid-1990s (TCE/TA of 6
on government guarantees, and securitization percent) (see the April 2009 GFSR).


Short-Term Prospects Are Precarious ket volatility. Moreover, the process of removing
bad assets, deleveraging balance sheets, and
As the vicious circle between the real and
restoring market institutions will be protracted.
financial sectors has intensified, global econom-
Thus, as discussed in the April 2009 GFSR,
ic prospects have been marked down further.
private credit in the advanced economies is pro-
Even assuming vigorous macroeconomic policy
jected to contract in both 2009 and 2010.
support and anticipating a moderation in the
Continuing stress and balance sheet adjust-
rate of contraction from the second quarter of
ment in mature markets will have serious
2009 onward, global activity is now projected
consequences for financing to emerging econo-
to decline 1.3 percent in 2009, a 1¾ percent-
mies. Overall, emerging markets are expected
age point downward revision from the January
to experience net capital outflows in 2009 of
WEO Update (Table 1.1). By any measure, this
more than 1 percent of their GDP. Only the
downturn represents by far the deepest global
highest-grade borrowers will be able to access
recession since the Great Depression (Box 1.1).
new funding, and rollover rates will decline
Moreover, all corners of the globe are being
well below 100 percent, as both bank and
affected: output per capita is projected to
portfolio flows are affected by financial dele-
decline in countries representing three-quarters
veraging and a growing tendency toward home
of the global economy, and growth in virtually
bias (Table A13). Although conditions should
all countries has decelerated sharply from rates
improve moderately in 2010, the availability of
observed in 2003–07. Growth is projected to
external financing to emerging and develop-
reemerge in 2010, but at 1.9 percent would still
ing economies will remain highly curtailed.
be well below potential, consistent with findings
These assumptions are consistent with findings
in Chapter 3 that recoveries after financial crises
in Chapter 4 that the acute degree of stress in
are significantly slower than other recoveries.
mature markets and its concentration in the
That chapter also finds that the synchronized
banking system suggest that capital flows to
nature of the global downturn tends to weigh
against prospects for a speedy turnaround. emerging economies will suffer large declines
The key factor determining the course of and will recover only slowly.
the downturn and recovery will be the rate of The projected path to recovery also incorpo-
progress toward returning the financial sector rates sustained strong macroeconomic support
to health. Underlying the downgrade to the for aggregate demand. Monetary policy interest
current forecast is the recognition that financial rates will be lowered to or remain near the zero
stabilization will take longer than previously bound in the major advanced economies, while
envisaged, given the complexities involved in central banks will continue to seek ways to use
dealing with bad assets and restoring confi- their balance sheets to ease credit conditions.
dence in bank balance sheets, especially against The projections build in fiscal stimulus plans
the backdrop of a deepening downturn in activ- in G20 countries amounting to 2 percent of
ity that continues to expand losses on a wide GDP in 2009 and 1½ percent of GDP in 2010, as
range of bank assets. It also recognizes the for- well as the operation of automatic stabilizers in
midable political economy challenges of “bail- most of these countries.2 In the major advanced
ing out” those who have made mistakes in the
2The note prepared by the IMF staff for the March
past. Thus, the baseline envisages that financial
2009 London meeting of the G20 (IMF, 2009f) provides
strains in the mature markets will remain heavy more detailed estimates of fiscal support on a country-by-
until well into 2010, improving only slowly as country basis. This note estimates that such support will
greater clarity over losses on bad assets and boost GDP in 2009 across the G20 by ¾–3¼ percentage
points, based on a range of estimates for fiscal multipli-
injections of public capital reduce insolvency ers. About one-third of these benefits derive from cross-
concerns and lower counterparty risks and mar- border spillovers.


Table 1.1. Overview of the World Economic Outlook Projections

(Percent change, unless otherwise noted)
Year over Year
Difference from Q4 over Q4
January 2009
Projections WEO Projections Estimates Projections
2007 2008 2009 2010 2009 2010 2008 2009 2010
World output1 5.2 3.2 –1.3 1.9 –1.8 –1.1 0.2 –0.6 2.6
Advanced economies 2.7 0.9 –3.8 0.0 –1.8 –1.1 –1.7 –2.6 1.0
United States 2.0 1.1 –2.8 0.0 –1.2 –1.6 –0.8 –2.2 1.5
Euro area 2.7 0.9 –4.2 –0.4 –2.2 –0.6 –1.4 –3.5 0.6
Germany 2.5 1.3 –5.6 –1.0 –3.1 –1.1 –1.7 –4.4 0.0
France 2.1 0.7 –3.0 0.4 –1.1 –0.3 –1.0 –2.2 1.4
Italy 1.6 –1.0 –4.4 –0.4 –2.3 –0.3 –2.9 –2.9 0.2
Spain 3.7 1.2 –3.0 –0.7 –1.3 –0.6 –0.7 –2.9 0.2
Japan 2.4 –0.6 –6.2 0.5 –3.6 –0.1 –4.3 –2.7 –0.6
United Kingdom 3.0 0.7 –4.1 –0.4 –1.3 –0.6 –2.0 –3.2 0.6
Canada 2.7 0.5 –2.5 1.2 –1.3 –0.4 –0.7 –1.9 1.7
Other advanced economies 4.7 1.6 –4.1 0.6 –1.7 –1.6 –2.7 –1.9 1.7
Newly industrialized Asian economies 5.7 1.5 –5.6 0.8 –1.7 –2.3 –4.8 –1.5 2.0
Emerging and developing economies2 8.3 6.1 1.6 4.0 –1.7 –1.0 3.3 2.3 5.0
Africa 6.2 5.2 2.0 3.9 –1.4 –1.0 ... ... ...
Sub-Sahara 6.9 5.5 1.7 3.8 –1.8 –1.2 ... ... ...
Central and eastern Europe 5.4 2.9 –3.7 0.8 –3.3 –1.7 ... ... ...
Commonwealth of Independent States 8.6 5.5 –5.1 1.2 –4.7 –1.0 ... ... ...
Russia 8.1 5.6 –6.0 0.5 –5.3 –0.8 1.2 –4.7 1.0
Excluding Russia 9.9 5.3 –2.9 3.1 –3.2 –1.3 ... ... ...
Developing Asia 10.6 7.7 4.8 6.1 –0.7 –0.8 ... ... ...
China 13.0 9.0 6.5 7.5 –0.2 –0.5 6.8 6.9 7.9
India 9.3 7.3 4.5 5.6 –0.6 –0.9 4.5 4.8 5.9
ASEAN–5 6.3 4.9 0.0 2.3 –2.7 –1.8 2.1 1.2 3.3
Middle East 6.3 5.9 2.5 3.5 –1.4 –1.2 ... ... ...
Western Hemisphere 5.7 4.2 –1.5 1.6 –2.6 –1.4 ... ... ...
Brazil 5.7 5.1 –1.3 2.2 –3.1 –1.3 1.2 1.1 2.4
Mexico 3.3 1.3 –3.7 1.0 –3.4 –1.1 –1.7 –2.1 2.5
European Union 3.1 1.1 –4.0 –0.3 –2.2 –0.8 ... ... ...
World growth based on market exchange rates 3.8 2.1 –2.5 1.0 –1.9 –1.1 ... ... ...
World trade volume (goods and services) 7.2 3.3 –11.0 0.6 –8.2 –2.6 ... ... ...
Advanced economies 4.7 0.4 –12.1 0.4 –9.0 –1.5 ... ... ...
Emerging and developing economies 14.0 10.9 –8.8 0.6 –6.6 –5.2 ... ... ...
Advanced economies 6.1 1.8 –13.5 0.5 –9.8 –1.6 ... ... ...
Emerging and developing economies 9.5 6.0 –6.4 1.2 –5.6 –4.2 ... ... ...
Commodity prices (U.S. dollars)
Oil3 10.7 36.4 –46.4 20.2 2.1 0.2 ... ... ...
Nonfuel (average based on world commodity
export weights) 14.1 7.5 –27.9 4.4 1.2 –2.9 ... ... ...
Consumer prices
Advanced economies 2.2 3.4 –0.2 0.3 –0.5 –0.5 2.1 –0.1 0.4
Emerging and developing economies2 6.4 9.3 5.7 4.7 –0.1 –0.3 7.7 4.4 4.0
London interbank offered rate (percent)4
On U.S. dollar deposits 5.3 3.0 1.5 1.4 0.2 –1.5 ... ... ...
On euro deposits 4.3 4.6 1.6 2.0 –0.6 –0.7 ... ... ...
On Japanese yen deposits 0.9 1.0 1.0 0.5 0.0 0.1 ... ... ...
Note: Real effective exchange rates are assumed to remain constant at the levels prevailing during February 25–March 25, 2009. Country
weights used to construct aggregate growth rates for groups of countries were revised.
1The quarterly estimates and projections account for 90 percent of the world purchasing-power-parity weights.
2The quarterly estimates and projections account for approximately 77 percent of the emerging and developing economies.
3Simple 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

$97.03 in 2008; the assumed price based on future markets is $52.00 in 2009 and $62.50 in 2010.
4Six-month rate for the United States and Japan. Three-month rate for the euro area.


Box 1.1. Global Business Cycles

The global economy is experiencing its deep- opments in advanced economies and those in
est downturn in 50 years. Many observers have emerging and developing economies, increas-
argued that this downturn has all the features of ing the odds of synchronous movements and a
a global recession. One problem with this debate, global business cycle.
however, is that there is little empirical work on
global business cycles. This box seeks to fill this Dating Global Business Cycles
gap, defining global business cycles, providing a The two standard methods of dating peaks
brief description of their main features, and thus and troughs of business cycles in individual
putting the current downturn in perspective. countries—statistical procedures and judgmen-
What constitutes a global business cycle? tal methods such as those used by the National
In the 1960s, it was sufficient to answer this Bureau of Economic Research (NBER) and the
question by looking at cyclical fluctuations Center for Economic Policy Research (CEPR),
in advanced economies, the United States in for instance, for the United States and the euro
particular. These countries accounted for the area, respectively—are applied at the global
lion’s share of world output, nearly 70 per- level. Both methods yield the same turning
cent on a purchasing-power-parity (PPP) basis; points in global activity.
moreover, cyclical activity in much of the rest of The statistical method is employed to date the
the world was largely dependent on conditions peaks and troughs in a key indicator of global
in advanced economies.1 Today, with the share economic activity, world real GDP per capita
of advanced economies in world output down (on the basis of PPP weights).2 Annual data
to about 55 percent on a PPP basis, the coinci- from 1960 to 2010 are used, with the estimates
dence between business cycles in these countries for 2009–10 based on the latest World Economic
and global business cycles can no longer be Outlook growth forecasts.3 A per capita measure
taken for granted. Indeed, in 2007, as the slow- is used to account for the heterogeneity in
down in economic activity in the United States population growth rates across countries—in
and other advanced economies began, the hope particular, emerging and developing economies
was that emerging and developing economies tend to have faster GDP growth than industrial-
would be somewhat insulated from these devel- ized economies, but they also have more rapid
opments by the size and strength of domestic population growth.
demand in their economies and by the increased The algorithm picks out four troughs in global
importance of intraregional trade in Asia. economic activity over the past 50 years—1975,
At the same time, however, the countries of 1982, 1991, and 2009—which correspond to
the world are more integrated today through declines in world real GDP per capita (first fig-
trade and financial flows than in the 1960s, ure, top panel). Notably, 1998 and 2001 are not
creating greater potential for spillover and con- identified as troughs, since world real GDP per
tagion effects. This increases the feedback, in
both directions, between business cycle devel-
2The method determines the peaks and troughs in
the level of economic activity by searching for changes
The authors of this box are M. Ayhan Kose, Prakash over a given period of time. For annual data, it basi-
Loungani, and Marco E. Terrones. David Low and cally requires a minimum two-year duration of a cycle
Jair Rodriguez provided research assistance. and a minimum one-year duration of each of the cycli-
1With market exchange rates, the share of advanced cal phases. A complete cycle goes from one peak to
economies in world output is about 75 percent. Chap- the next peak with its two phases, the recession phase
ter 4 of the April 2007 World Economic Outlook analyzes (from peak to trough) and the expansion phase (from
the evolution of the distribution of world output and trough to peak); see Claessens, Kose, and Terrones
studies how the impact of growth in advanced econo- (2008).
mies on developing economies’ economic perfor- 3The sample used to calculate this measure includes

mance has changed over time. almost all the countries in the WEO database.


Box 1.1 (continued)

The use of market weights rather than PPP

Real per Capita World GDP1 weights, which tilts the weights toward advanced
(Contractions in purchasing-power-parity (PPP)-
economies, does not affect the identification
weighted global per capita GDP are shaded)
of the troughs, except the one in 1991. When
the market weights are used, the trough of this
PPP-weighted Index
(1960 = 100) episode shifts to 1993 because of the downturns
in many European countries during the Euro-
250 pean exchange rate mechanism (ERM) crisis
of 1992–93. However, with both weights, the
current projections suggest that the 2009 global
recession would be by far the deepest recession
in five decades (first figure, bottom panel).5
A Broader Assessment of Turning Points
In contrast to a statistical approach, the NBER
and CEPR date business cycle peaks and troughs
by looking at a broad set of macroeconomic indi-
50 cators and reaching a judgment on whether a pre-
1960 70 80 90 2000 10
ponderance of the evidence points to a recession.
Percent Change The CEPR’s task is much more complex than that
of the NBER because, in addition to looking at
PPP weights
4 multiple indicators, it has to make a determination
3 of whether the euro area as a whole is in recession.
This approach is applied at the global level
by looking at several indicators of global activ-
1 ity—real GDP per capita, industrial produc-
0 tion, trade, capital flows, oil consumption,
and unemployment.6 The second figure shows
the behavior of these indicators on average
Market weights -2

a global recession, certainly in comparison with earlier
1960 70 80 90 2000 10 episodes that we would have labeled as global reces-
sions. That said, it was a close call.” See Chapter 1 of
Source: IMF staff estimates.
the April 2002 World Economic Outlook for details.
1Data for 2009–10 are based on the WEO forecast. 5By construction, the episodes of global recession

the algorithm picks out correspond exactly to periods

capita did not decline. In 1997–98 many emerging of falling world real GDP per capita. With both
economies, particularly in Asia, had sharp declines weights, the dates of peaks in the global business cycle
in economic activity, but growth in advanced are 1974, 1981, 1990, and 2008. If total (rather than
per capita) real GDP is used, 2009 is the only contrac-
economies held up. In 2001, conversely, many
tion the global economy experienced since 1960.
advanced economies had mild recessions, but 6The data for unemployment are available only for

growth in major emerging markets such as China a selected number of advanced economies for the full
and India remained robust.4 sample period. Long time series on unemployment for
emerging and developing economies are difficult to
obtain; moreover, the presence of large informal sec-
4The analysis in Box 1.1 in the April 2002 World tors in many of these countries lowers the usefulness
Economic Outlook, “Was It a Global Recession?” also con- of the official unemployment rate as an indicator of
cluded that the 2001 episode “falls somewhere short of labor market conditions.


around the global recessions of 1975, 1982, and

Selected Variables around World Recessions
1991 that were identified using the statistical
(Annual percent change unless otherwise noted; years
approach. World industrial production and oil on x-axis; trough in output at t = 0)
consumption start to slow two years before the
trough and world trade and capital flows one Average Current
year before. The unemployment rate registers
its sharpest increase in the year of the reces- 5 Real per Capita GDP Industrial Production 8
sion. Unemployment remains high in the year 4 6
after the trough, while most other indicators 3 4
have recovered to close to their normal rates 2 2
of growth.7 The current recession is following a 1 0
pattern similar to that observed in past reces- 0 -2
sions, though the contractions in most indica- -1 -4
-2 -6
tors are much sharper this time.
-3 -8
Although the four global recessions share -4 -3 -2 -1 0 1 2 3 4 -4 -3 -2 -1 0 1 2 3 4
similar qualitative features, there are some
important quantitative differences among them. 10 Unemployment Rate1 Total Trade 12
The table shows percent changes in the selected 9 8
indicators of global activity over the course of
8 4
the recessions. There are sharper declines in
7 0
almost all indicators in 1975 and 1982 than in
1991; in 1991, in fact, world trade grew strongly 6 -4
despite the recession. Capital flows registered 5 -8
declines in 1982 and 1991, but those changes 4 -12
are much smaller than the massive contraction -4 -3 -2 -1 0 1 2 3 4 -4 -3 -2 -1 0 1 2 3 4

during the ongoing episode. Unemployment

is expected to increase by about 2.5 percent- 6 Capital Flows2 Oil Consumption 5

age points during the current recession, which 4 4

would be larger than in earlier recessions. 2 3

The severity of the 2009 recession is also 0 2
indicated by the forecast decline in per capita -2 1
consumption, which is much greater than that -4 0
observed in 1982 and contrasts with the increase -6 -1
in consumption during the two other global -8 -2
-4 -3 -2 -1 0 1 2 3 4 -4 -3 -2 -1 0 1 2 3 4
recessions. Per capita investment declined in
all global recessions, but the projected decline
Source: IMF staff calculations.
1Unemployment rate in percent. Comprises data in the advanced
economies only.
2 Capital flows refer to the two year rolling window average of the

7During the years 1998 and 2001, the behavior

ratio of inflows plus outflows to GDP.

of these global indicators was mixed, supporting

the inference from the statistical method that these
in the present recession easily exceeds that
episodes did not display the features of a global reces- observed in previous episodes.
sion. The statistical method is also used to identify
the cyclical turning points in quarterly series of global Synchronicity of National Recessions
industrial production. The results are broadly con- The third figure shows yearly fluctuations in
sistent with those from the annual series of GDP but
they also indicate a trough in industrial production
the GDP-weighted fraction of countries that
over the period 2000:Q4–2001:Q4. have experienced a recession, defined here as


Box 1.1 (concluded)

Global Recessions: Selected Indicators of Economic Activity advanced economies are expected to be
(Percent change, unless otherwise indicated) in recession. The degree of synchronicity
Average of the current recession is the highest to
Projected (1975, 1982, date over the past 50 years. Although it
Variable 1975 1982 1991 2009 1991) is clearly driven by declines in activity in
Output the advanced economies, recessions in
Per capita output a number of emerging and developing
(PPP1 weighted) –0.13 –0.89 –0.18 –2.50 –0.40
Per capita output economies are contributing to its depth
(market weighted) –0.33 –1.08 –1.45 –3.68 –0.95 and synchronicity.
Other macroeconomic To summarize, the 2009 forecasts
Industrial production –1.60 –4.33 –0.09 –6.23 –2.01 of economic activity, if realized, would
Total trade –1.87 –0.69 4.01 –11.75 0.48 qualify this year as the most severe global
Capital flows2 0.56 –0.76 –2.07 –6.18 –0.76 recession during the postwar period.
Oil consumption –0.90 –2.87 0.01 –1.50 –1.25 Most indicators are expected to regis-
Unemployment3 1.19 1.61 0.72 2.56 1.18
ter sharper declines than in previous
Components of output
Per capita episodes of global recession. In addition
consumption 0.41 –0.18 0.62 –1.11 0.28 to its severity, this global recession also
Per capita investment –2.04 –4.72 –0.15 –8.74 –2.30 qualifies as the most synchronized, as
Note: The 1991 recession lasted until 1993, using market weights; all other virtually all the advanced economies and
recessions lasted one year. many emerging and developing econo-
1PPP = purchasing power parity.
2Refers to change in the two-year rolling window average of the ratio of mies are in recession.
inflows plus outflows to GDP.
3Refers to percentage point change in the rate of unemployment.

Countries Experiencing Recessions1

a decline in real GDP per capita.8 Not surpris- (Purchasing-power-parity (PPP)-weighted percent of
ingly, the percentage of countries experienc- countries)
ing recession goes up sharply during the four Advanced economies
global recessions. Although the 1975 recession Emerging and developing economies
was driven largely by declines in industrialized
economies, emerging and developing econo- 80
Contractions in
mies played a role in the other three episodes. PPP-weighted global per
In 1982, recessions in many Latin American capita GDP
economies contributed to the decline in global
activity, whereas in 1991 declines in the transi-
tion economies played an important role. The 50
1991 recession was a multiyear episode in which
the U.S. recession in 1990–91 was followed by 40
recessions among European countries during
the ERM crisis. 30

The period 2006–07 stands out as one in which

the number of countries in recession was at a
historical low. However, it is being followed by a
sharp reversal in fortune. In 2009, almost all the
1960 70 80 90 2000 10
8Countries are weighted by their PPP weights;
hence, the countries that are larger in economic size Source: IMF staff estimates.
1Data for 2009–10 are based on the WEO forecast.
receive a greater weight in this figure.


economies, the fiscal deficit is projected to

jump to 10½ percent of GDP in 2009 from less Figure 1.8. Global Outlook
than 2 percent in 2007 (see Table A8), with (Real GDP; percent change from a year earlier)
half of the deterioration reflecting the impact
of fiscal stimulus and financial support (IMF, The global economy is projected to undergo a deep and prolonged recession in 2009
with growth only returning at a gradual pace in 2010 based on strong policy actions.
2009e). Such a combined deficit would be far A wide range of advanced and emerging economies are projected to suffer substantial
greater than anything experienced since World contractions in economic activity in 2009.
War II. Fiscal balances are expected to deterio-
rate in the emerging and developing economies 10 6
Emerging United States
too, swinging from a small overall surplus in 8 economies
2007 to a deficit of 4 percent of GDP in 2009, 6 World
with a relatively large component resulting from 4 0
declining commodity and asset prices. 2
The third key assumption is that commodity 0 area -3

prices will remain around current levels in 2009 -2 Advanced

economies1 -6
and will rise only modestly in 2010 as a recovery -4
finally gets under way, consistent with pricing in -6 -9
2000 02 04 06 08 10 2000 02 04 06 08 10
forward markets. Restrained commodity prices,
together with rising output gaps, will imply a 16 10
continued sharp deceleration of global inflation, India Emerging Europe 4
12 8
as well as redistribution of purchasing power to
commodity-importing countries, which will pro- 8
vide substantial support for demand in advanced 4
economies (additional purchasing power on the ASEAN-4 2 Brazil 2
order of 1½ percent of GDP) but will negatively 0
affect commodity exporters. NIEs
-4 -2
Latin America5
On this basis, the advanced economies are
-8 -4
projected to suffer deep recessions. Overall 2000 02 04 06 08 10 2000 02 04 06 08 10

output is projected to contract by 2.6 percent

15 8
(measured fourth quarter over fourth quarter)
CIS 6 7
during 2009 (Figure 1.8). Following a very weak 10
first quarter, the rate of contraction should mod- 6

erate, as economies receive support from fiscal 5 5

stimulus and the drag from inventory adjust- 4
0 3
ment diminishes. In 2010, output is expected
Middle East 2
to increase gradually over the course of the -5
year—by 1.0 percent—still well below potential, 1

implying a continuing rise in unemployment to -10

2000 02 04 06 08 10 2000 02 04 06 08 10
over 9 percent. Among the major economies,
the United States and the United Kingdom Sources: Haver Analytics; and World Economic Outlook (WEO) database.
1Australia, Canada, Czech Republic, Denmark, euro area, Hong Kong SAR, Israel, Japan,
will continue to suffer most heavily from credit Korea, New Zealand, Norway, Singapore, Sweden, Switzerland, Taiwan Province of China,
constraints, given the direct damage to their United Kingdom, and United States.
2Indonesia, Malaysia, Philippines, and Thailand.
financial institutions, major housing corrections, 3
Newly industrialized Asian economies (NIEs) comprise Hong Kong SAR, Korea,
and reliance on household borrowing to sup- Singapore, and Taiwan Province of China.
4Estonia, Hungary, Latvia, Lithuania, and Poland.
port consumption. The euro area will experi- 5Argentina, Brazil, Chile, Colombia, Mexico, Peru, and Venezuela.
6Commonwealth of Independent States.
ence an even deeper decline in activity than the
United States as the sharp contraction in export


sectors increasingly curtails domestic demand

against the backdrop of financial stress and
housing corrections in some national markets.
In Japan, the downturn is exceptionally severe,
Figure 1.9. Potential Growth and the Output Gap1 and is being driven largely by trade, which has
been hit hard because of the economy’s heavy
The severe global recession will imply a sharp widening in output gaps, particularly
in the advanced economies, but will also affect most emerging economies. These
reliance on manufacturing exports, and by
gaps are expected to close only slowly over the medium term, implying persistently spillovers to domestic investment. Japan’s output
high levels of unemployment.
gap is projected to rise above 8 percent—the
widest among the major advanced economies
Real and Potential GDP Growth2 10
Emerging (Figure 1.9).
8 Emerging and developing economies as a
World 6 group are still projected to eke out a modest
4 1.6 percent growth in 2009, rising to 4 percent
in 2010. However, real GDP is expected to
contract across a wide swathe of countries in
2009. The biggest output declines are projected
economies -2
in the CIS countries, as a reversal of capital
-4 flows has punctured credit booms and commod-
1980 85 90 95 2000 05 10 14
ity export revenues have dwindled. Countries
Output Gap: World Economy 4
in emerging Europe are having to adjust to a
Emerging World sharp curtailment of external financing, as well
2 as a drop in demand from western Europe. East
Asia’s exporters, like Japan, have been hit hard
from the collapse in demand for manufacturing
Advanced -2 exports. China and India will see growth drop-
economies ping sharply, but are still expected to achieve
-4 solid rates of growth by the standards of other
countries, given the momentum of domestic
1980 85 90 95 2000 05 10 14 demand (reinforced, particularly in China, by
policy easing). Middle Eastern oil exporters are
6 Output Gap: Advanced Output Gap: Emerging 6
Economies Economies
using financial reserves to maintain government
Emerging 4 spending plans to cushion the impact of lower
3 United
States Europe
2 oil prices. In Latin America, recent prudent
0 0 macroeconomic management in many countries
has provided buffers, but economies are heav-
-3 -2
Euro area Asia ily affected by declines in export volumes, weak
-6 Latin commodity prices, and tight external financing
Japan America -6 conditions. African economies are also being
2000 02 04 06 08 10 12 14 2000 02 04 06 08 10 12 14
-8 squeezed by declines in commodity export
prices and export markets, but most are less reli-
Source: IMF staff estimates. ant on external financing.
1 Estimates of the output gap, in percent of potential GDP, are based on IMF staff calculations.
2 GDP growth rates of actual (solid line) versus potential (dashed line) for advanced economies.
For emerging economies, Hodrick-Prescott filter applied for potential GDP.
Downside Risks Predominate
The current outlook is exceptionally uncer-
tain, with risks still weighing on the downside,


despite the lowering of the baselines, as illus-

trated in the fan chart for global growth (Fig-
ure 1.10). This fan chart is now constructed
based on market indicators, as explained in
Appendix 1.2. These indicators suggest that
the variance of growth risk is at present much
greater than normal and also indicate the down-
ward skewness of risks.
Before exploring these downside risks, it
should be acknowledged that there is upside
potential to the outlook. Bold policy imple-
mentation that is able to convince markets that
financial strains are being decisively dealt with Figure 1.10. Risks to World GDP Growth1
(Percent change)
could set off a mutually reinforcing “relief rally”
in markets, a revival in business and consumer The outlook is exceptionally uncertain, with risks to the forecast still weighing to the
confidence, and a greater willingness to make downside. See Appendix 1.2 for details of how the variance and skewness of the fan
chart are related to market indicators.
longer-term spending commitments. The prob-
lem is that the longer the downturn continues
to deepen, the slimmer the chances that such a
strong rebound will occur, as pessimism about 5

the outlook becomes entrenched and balance 4

sheets are damaged further. 3
Turning to the downside, a dominant concern
is that policies will continue to be insufficient to
arrest the negative feedback between deteriorat- 1

ing financial conditions and weakening econo- 0

mies in the face of limited public support for -1
Baseline forecast
policy action. The core of the problem is that 50 percent confidence interval
as activity contracts across the globe, the threat 70 percent confidence interval
90 percent confidence interval -3
of rising corporate and household defaults will
imply still-higher risk spreads, further falls in -4
2006 07 08 09 10
asset prices, and greater losses across financial
balance sheets. The risks of systemic events will Source: IMF staff estimates.
rise, the tasks of restoring credibility and trust 1The fan chart shows the uncertainty around the WEO central forecast with 50, 70, and
90 percent probability intervals. As shown, the 70 percent confidence interval includes the
will be complicated, and the fiscal costs of bank 50 percent interval, and the 90 percent confidence interval includes the 50 and 70 percent
rescues will escalate further. Moreover, a wide intervals.

range of financial institutions—including life

insurance companies and pension funds—will
run into serious difficulties. In turn, additional
stress in the financial sector will drive greater
deleveraging and asset sales, tightening of access
to credit, greater uncertainty, higher saving
rates, and even more severe and prolonged
recessions. In a highly uncertain context, fiscal
and monetary policies may fail to gain trac-
tion, since high rates of precautionary saving
could lower fiscal multipliers and steps to ease


Figure 1.11. Housing Developments funding could fail to slow the momentum of
House prices have decelerated sharply across a broad range of advanced These negative interactions would operate
economies and are now falling in a number of markets. Nevertheless, house price through a complex series of interrelated chan-
misalignments remain substantial in many countries.
nels that would play across both advanced and
emerging economies. Key transmission routes
30 Residential Property Prices Residential Property Prices 30
(12-month percent change) (12-month percent change) include deep corrections in national hous-
20 United United Spain France 20 ing markets, especially but not exclusively in
States Kingdom
advanced economies; corporate stress, especially
10 10 but not exclusively in emerging economies;
Italy deflation risks, mainly in advanced economies;
0 Canada 0
and increasing vulnerabilities in public sector
Japan balance sheets, especially but not only in emerg-
-10 -10
1995 97 99 2001 03 05 07 08: 1995 97 99 2001 03 05 07 08: ing economies. Each of these risks is discussed in
Q4 Q4
turn below, before the section concludes with a
1.8 Price-to-Income Ratio Price-to-Income Ratio 1.8 negative downside scenario to illustrate the pos-
United Italy sible combined impact on the global economy.
United Spain
1.5 States Kingdom 1.5
Japan France
1.2 1.2 When Will Housing Slumps End?
The slump in the U.S. housing market was
0.9 0.9
the immediate trigger for the subprime crisis
0.6 0.6 and the source of continuing heavy losses to the
1970 75 80 85 90 95 2000 05 08: 1970 75 80 85 90 95 2000 05 08:
Q4 Q4 financial system, declines in household wealth,
and dropping construction activity, which
1 House Price Misalignments1
40 House Price Misalignments 40 remain major drags on U.S. economic activity.3
30 United 30 The baseline projections envisage stabilization
Kingdom United Spain
20 States 20 and turnaround in this sector after a further
10 10 10–15 percent drop in house prices (measured
0 0 by the Case-Shiller 20-city index) that would
-10 Japan Germany -10 lower U.S. house prices by more than 35 per-
-20 Canada -20 cent from their peak, bring valuation ratios
-30 -30 more closely in line with medium-term norms,
1997 99 2001 03 05 07 08: 1997 99 2001 03 05 07 08:
Q3 Q3 and leave construction activity well below previ-
ous cyclical troughs (Figure 1.11). However,
8 Residential Investment Residential Investment 10
(percent of GDP) (percent of GDP) rising unemployment and an increasing share
7 9
Canada of households with “negative equity” (house
Germany Spain 8
6 Japan prices are currently below outstanding mort-
United 7
5 gages for 20 percent of borrowers) threaten a
States France 6
4 further increase in foreclosure rates that could
generate serious overshooting and continued
3 United Italy 4
Kingdom housing weakness through 2010. This concern
2 3
1995 97 99 2001 03 05 07 08: 1995 97 99 2001 03 05 07 08: underlines the importance of effective imple-
Q4 Q4
mentation of recent government initiatives to
Sources: Haver Analytics; Organization for Economic Cooperation and Development,
Economic Outlook; and IMF staff calculations. 3These connections are explored in Box 1.2 in the
1Estimates based on methodology described in Box 1.2 of the October 2008 World
Economic Outlook. October 2008 World Economic Outlook.


facilitate mortgage restructuring and to ensure sector in emerging economies. In total, these
an adequate supply of credit. economies face rollover needs (short-term
Many European housing markets also suf- debt plus amortization of medium- and long-
fered from boom conditions in recent years, term debt) of $1.8 trillion in 2009. The bulk
and IMF staff estimates suggest that house price of requirements will come from the corporate
misalignments were as large or even larger than sector, particularly in emerging Europe (see the
in the United States in a number of countries. April 2009 GFSR). The risk is that such rollover
Although not all national markets were affected, needs will not be met because external financ-
Ireland, Spain, and the United Kingdom are ing will be curtailed even more sharply than
now experiencing major corrections that most anticipated in the baseline projections, in the
likely have a considerable distance still to run. context of deteriorating economic prospects and
A number of countries in emerging Europe intense global deleveraging.
are also suffering major housing downturns, Emerging economies are especially exposed
and for some of these countries, the situation is because factors that are generally pushing
made more dangerous because a high propor- banks to retrench from cross-border positions,
tion of mortgages are denominated in foreign such as swap market dislocations and the high
currencies, implying a rising burden on house- cost of foreign currency liquidity, are exacer-
holds if currencies move abruptly. Downside bated. Moreover, hedge funds and other emerg-
risks include overshooting in western European ing market portfolio investors face continued
markets already experiencing major corrections, pressures to deleverage positions from lack of
more severe corrections in other markets where access to funding and from redemptions. Banks
there are indicators of significant house price that have been a dominant source of funding in
misalignments (although household leverage is emerging Europe could start to cut exposures,
much lower than elsewhere), and rising house- and rollover rates for maturing short-term cred-
hold stress in emerging Europe. its could fall sharply, as occurred, for example,
during the Asian crisis. To date, subsidiaries of
foreign banks operating in emerging Europe
Rising Threat of Emerging Market Corporate have largely maintained their exposures, given
Defaults long-term business interests in the region, but
As the global downturn deepens and credit the situation could shift quickly as conditions
markets remain severely impaired, the threat of deteriorate.
corporate defaults is rising to dangerous levels, Sudden stops in external financing could
particularly in those emerging economies most trigger dangerous repercussions, because liquid-
dependent on external financing. ity problems could rapidly become threats to
As shown in Box 1.2, the nonfinancial cor- solvency, as has happened too often in the past.
porate sector in both advanced and emerging Corporations that previously relied on foreign
economies took advantage of the boom years funding may try to shift to domestic funding
over 2003–07 to strengthen balance sheets— markets, adding to pressures on smaller local
lowering leverage and raising liquidity—and to enterprises. Rapid exchange rate deprecia-
boost returns on assets. However, the economic tion would add to pressure on balance sheets,
downturn and financial crisis have already particularly for borrowers with large foreign
brought considerable corporate distress in their currency exposures.
wake, and bankruptcies have risen sharply, Countries that have accumulated stockpiles of
notably in the United States. foreign reserves and have sound public balance
Dealing with corporate bankruptcies will be sheets would have room to buffer the impact
a major challenge in the advanced economies, through policy responses, but these buffers are
but an even greater threat lies in the corporate in danger of being eroded over time if the loss


Box 1.2. How Vulnerable Are Nonfinancial Firms?

This question is more relevant than usual for

assessing the outlook for the financial sector
and the broader economy. The balance-sheet Selected Balance Sheet Indicators for
and market-based indicators presented in this Nonfinancial Firms1
box show that the resilience of the nonfinan- Developed Americas Emerging Americas
cial corporate sector to shocks has improved Developed Europe Emerging Europe and Russia
Developed Asia Emerging Asia
considerably since the late 1990s and until
recently has been a supporting factor for the Debt-Equity Ratio
400 400
financial sectors and economies affected by the
crisis. Yet as the financial crisis has deepened 300 300

and the economic recession has become more 200 200

synchronized between advanced and emerg-
100 100
ing economies, balance sheets of nonfinancial
0 0
firms across the world have started to weaken. 1994 97 2000 03 06 1994 97 2000 03 06
A further deterioration in the health of the Interest Coverage Ratio
70 70
nonfinancial corporate sector now risks trig- 60 60
gering further losses in the banking sector and 50 50
40 40
intensifying the vicious macrofinancial feed- 30 30
back in this global crisis. 20 20
10 10
For several years prior to the current crisis, 0 0
leverage in the nonfinancial corporate sector -10 -10
1994 97 2000 03 06 1994 97 2000 03 06
declined steadily, largely owing to successful
Return on Assets
restructuring exercises following previous stress 20 20

episodes (particularly, the Japanese crisis, the 16 16

Asian crisis, and the bursting of the dot-com 12 12
bubble). At the start of the present crisis, the 8 8
degree of leverage in advanced and emerging 4 4
economies’ firms was broadly similar (first fig- 0
1994 97 2000 03 06 1994 97 2000 03 06
ure, top panel). In Asia, in particular, leverage 2
Expected Default Probability One Year Ahead
was down significantly from the Asian crisis 25 25
peaks. Emerging European and Russian firms 20 20
enjoyed particularly low leverage owing to high 15 15
oil prices and asset valuations.
10 10
Other balance-sheet indicators also regis-
5 5
tered an improvement in the run-up to the cri-
0 0
sis. In particular, subdued investment and easy 1994 97 2000 03 06 1994 97 2000 03 06

access to credit helped boost corporate liquid-

ity (first figure, second panel). Profitability was Sources: Worldscope; and IMF staff calculations.
1In percent. Regional aggregates are computed by weighing
also strong, especially in emerging Europe and country data by market capitalization valued at market exchange
Russia (first figure, third panel). rates. Within countries, firm-level data are also weighed by market
capitalization, to focus on the default risk of the largest,
Stronger balance sheets implied a lower risk economically most important firms.
2Default probabilities are calculated based on so-called Z-scores
of insolvency in response to shocks, reducing
—a weighted sum of the ratio of working capital to total assets,
the value of assets and equity. Measures of retained earnings to total assets, earnings before interest and taxes,
default probability based on accounting data total assets, market value of equity to total liabilities, and sales to
total assets. The weights are estimated for a sample of U.S. firms
(Altman, 1968).
The main authors of this box are Dale Gray and
Natalia Tamirisa, with assistance from Ercument
Tulun and Jessie Yang.


mies’ firms declined to advanced economies’

Selected Market-Based Indicators for levels or even lower (for emerging Europe and
Nonfinancial Firms1 Russia). Based on accounting data, the likeli-
hood of default among advanced economies’
United States East Asia and China firms was broadly the same as before the
Japan Emerging Europe and Russia
Euro area Latin America previous crisis episodes, such as, for example,
South Asia the bursting of the dot-com bubble of the
early 2000s and the Japanese financial crisis.
Expected Default Frequency One Year Ahead Market-based measures of default probabilities
30 30 and leverage paint a broadly similar picture
(second figure).
Since the onset of the financial crisis, bal-
ance sheets of nonfinancial firms across the
world have weakened significantly. At the
10 10 beginning of the crisis in 2007, the debt-equity
ratios in western Europe and the United States
0 0
rose in tandem with falling asset values. (Bal-
1994 97 2000 03 06 Feb. 1994 97 2000 03 06 Feb.
09 09
ance sheet data for 2008 are not available yet
for most nonfinancial firms.) The structure
Leverage of corporate debt in emerging economies is
90 90 generally more biased toward short-term debt.
80 80 And with the onset of the crisis, the reliance
70 70 of emerging economies’ firms on short-term
60 60 debt increased, especially in emerging Europe
50 50
and Russia, possibly reflecting preferences of
40 40
lenders concerned about vulnerabilities in the
region. The first year of the crisis saw a decline
30 30
in liquidity and profitability in the United
20 20
1994 97 2000 03 06 Feb. 1994 97 2000 03 06 Feb. States and to a lesser extent in western Europe,
09 09
as credit conditions tightened.
More recent market-based indicators suggest
Sources: Moody’s-KMV CreditEdgePlus database; and IMF staff
calculations. that corporate solvency risks rose sharply across
1In percent. Data refer to the 75th percentile of companies, which
the world following the collapse of Lehman
means that 25 percent of companies have default probabilities or
leverage above the plotted values. The 75th percentile default Brothers in September 2008. Among the G3
probabilities focus on the most vulnerable group of companies and
economies (United States, euro area, Japan),
tend to be considerably higher than the median values of default
probabilities. Leverage is calculated as the default barrier divided U.S. firms experienced the largest increase in
by the market value of assets. default probabilities, to levels that are more than
double those in the euro area and four times
higher than in Japan (second figure, top panel).1
showed that corporates in emerging econo-
mies—in Asia, emerging Europe and Russia, 1These default probabilities are calculated using a
and Latin America—were much less likely to contingent claims approach that uses equity market
default in 2006 than in 1996, just before the information combined with balance-sheet data to
onset of the late 1990s crises (first figure, estimate forward-looking default probabilities. The
bottom panel). Thanks to successful restruc- estimates are provided by Moody’s-KMVCreditEdge-
Plus, which is an extension of the original Contin-
turing and a long period of strong growth,
gent Claims Analysis model developed by Robert C.
the default probabilities of emerging econo- Merton, and is applied to 30,000 firms and 5,000


Box 1.2 (concluded)

As of February 2009, corporate default prob- crisis and global recession. Many nonfinancial
abilities in the United States were still below the firms in advanced and emerging economies
peaks experienced when the dot-com bubble have so far weathered the crisis by drawing on
burst in the early 2000s. However, corporate their large cash reserves, but plummeting exter-
default probabilities in Japan have already nal and domestic demand has recently started
reached previous crisis levels. Corporate default to take its toll on corporate cash revenues.
probabilities in emerging economies have also Firms with large outstanding external debt
risen since September 2008. The largest increases have been affected in some cases by exchange
occurred in south Asia, possibly owing to the rate depreciation. A financing squeeze has also
high leverage of Indian companies (second intensified, as manifested in tighter external
figure, bottom panel), their close production financing conditions, difficulties in obtaining
links with the United States, a collapse in equity trade finance, and domestic banks’ increased
prices, and a drop in real estate prices that has aversion to risk. Smaller and lower-credit-quality
undermined the position of construction firms.2 firms and firms with high rollover needs in 2009
The risk of default has also increased sharply are being more severely affected than others.
in emerging Europe and Russia, approaching A weakening of corporate balance sheets
previous crisis peaks. In Latin America and east is contributing to a slowdown in investment
Asia and China, however, corporate default prob- and, through a rise in nonperforming loans,
abilities remain considerably below the levels a deterioration in bank balance sheets. Such
experienced during the late 1990s crises. negative feedback loops are of particular con-
The position of nonfinancial firms is set to cern in emerging economies, where financial
weaken further amid the deepening financial sectors have so far weathered the crisis better
than financial sectors in advanced economies.
Nonfinancial corporate defaults also pose a risk
financial institutions in 55 countries. It provides for- for financial markets, as large-scale bankrupt-
ward-looking indicators of risk updated daily.
2For more details on corporate vulnerabilities in cies may heighten counterparty risks and cause
Asia, see the IMF’s Regional Economic Outlook for the spillovers to other countries’ banks, both in
Asia-Pacific region. Also see IMF (forthcoming). advanced and emerging economies.

of external financing is prolonged. Legal frame- that overheating and booming commodity prices
works for corporate restructuring are generally could stoke excessive inflation to the opposite
less well developed in emerging economies, worry—that price deflation could exacerbate
implying that rising distress would be more the downturn in activity, as occurred in Japan in
likely to lead to insolvency and liquidation. And the 1990s and more intensely during the Great
debt defaults would damage both domestic Depression of the 1930s.
financial systems and foreign creditors. Emerg- Inevitably, the aftermath of the sharp drop in
ing market banks already face large losses, and oil and food prices in the context of widening
these could be magnified, while banking sys- output gaps has been a rapid deceleration of
tems in western Europe that have built up large headline inflation. Consumer prices declined
exposures would also be vulnerable. at an annual rate of more than 4 percent in the
advanced economies during the fourth quarter
of 2008. Measures of core inflation and of 12-
Gauging Risks for Deflation month-ahead inflation expectations still remain
Since the summer of 2008, there has been in the 1–2 percent range, except in Japan (see
a sea change from concern in many countries Figure 1.3), but sustained high rates of excess


capacity together with sharp falls in house and risks around the baseline. As illustrated in the
equity prices threaten continued declines in box, there are considerable risks of sustained
consumer prices that could eventually lead to very low inflation (below ½ percent), moder-
entrenched expectations of price deflation. This ate deflation risk in the United States and the
would have two negative consequences. First, the euro area, and significant likelihood of deeper
ability of monetary authorities to provide stimu- price deflation in Japan. In each economy,
lus through low policy rates would be curtailed; policy interest rates are likely to remain close
indeed real interest rates could rise as deflation to the zero floor for a lengthy period, but real
intensifies with policy rates jammed against the rates could come under upward pressure in the
zero bound. Second, falling prices would imply weaker part of the range of outcomes as defla-
increasing real debt burdens on businesses and tion intensifies. Such outcomes would add to
households, adding to risks that weakening activ- negative momentum, underlining the need for
ity and financial stress would trigger widespread vigorous monetary policy responses to head off
defaults and providing a further twist to the such risks.
negative interaction between the real economy
and the financial sector.
How large are deflation risks? In the baseline Sovereigns under Stress
projections, 12-month consumer price index Like businesses, many governments in both
inflation falls well below zero in the first half advanced and emerging economies took advan-
of 2009 in both Japan and the United States tage of buoyant revenues in the 2003–07 boom
but returns to positive territory in the United years to strengthen their finances, bringing down
States and close to zero in Japan in the first half fiscal deficits and lowering public debt levels
of 2010. In western Europe, where energy has (although little progress was made to address lon-
a lower weight in consumption baskets, infla- ger-term demographic pressures on government
tion falls to low levels but mostly avoids going spending). However, the combination of dete-
negative. In most emerging economies, which riorating economic prospects, falling commod-
entered the crisis with substantially higher ity prices, and severe financial stress has raised
inflation and with excess demand, inflation is concerns about the potential for sharp increases
projected to remain solidly positive, although in debt issuance related to both widening fiscal
inflation in some east Asian economies (includ- deficits (from both stimulus measures and cyclical
ing China) is projected to be low or even nega- factors) and the use of public resources to sup-
tive in 2009. However, there are clearly downside port the financial and corporate sectors.
risks, especially in the event of weaker growth Against this backdrop, yield spreads and
outcomes and wider output gaps. Recent work prices on credit default swaps on government
by the IMF staff finds that an indicator of global securities have spiked upward across a range
deflation risk has now risen to well above levels of countries, even as yields on debt issued by
observed in 2002–03, when deflation was also major economies such as the United States,
a concern (Decressin and Laxton, 2009). This Germany, and Japan have declined. In the
index does not take into account weakness in advanced economies, among the most affected
housing markets nor the whole range of finan- have been those with a large and vulnerable
cial market strains, both of which add to defla- banking sector, whether from excessive leverage
tion concerns. (for example, Iceland), exposure to emerging
Box 1.3 investigates deflation risks in more Europe (Austria), or exposure to housing cor-
detail for the G3—United States, euro area, and rections (Ireland, Spain), although concerns
Japan—using a stochastic forecasting tool that over the impact of a prolonged downturn on
takes into account the zero interest floor and already weak fiscal positions have also played a
was developed by the IMF staff to explore the part (for example, Greece). Indeed, wide dif-


Box 1.3. Assessing Deflation Risks in the G3 Economies

Simulations with a version of the Global zero through 2010, and the bands indicate a
Projection Model, covering the United States, sizable continuing risk of deflation. The prob-
the euro area, and Japan, shed light on the ability that inflation will reach the Federal
risks of deflation in the current outlook.1 The Reserve’s comfort zone over the next two years
simulations assume that the relevant central is low.3
banks continue to pursue an objective for infla- In the baseline, U.S. GDP growth, on a four-
tion consistent with their behavior over the past quarter basis, troughs in 2009:Q2, at about
decade. In the model, they adjust their policy –3.0 percent; positive growth does not resume
interest rate according to an estimated mone- until mid-2010. Unemployment continues to
tary policy rule, which responds to the deviation rise through 2010 as employment growth lags
between expected and desired inflation and the output growth. At the peak unemployment
gap between actual and potential output. The rate, the confidence bands are somewhat wider
rule is, however, subject to the constraint of the above the median than below, suggesting that
zero interest rate floor (ZIF). downside risks exceed upside risks. This asym-
Model projections are constructed to be metry reflects nonlinearities; negative shocks
broadly consistent with the World Economic have increasingly negative effects, through
Outlook (WEO) baseline scenario; thus, they feedback between the real and financial sectors
reflect currently enacted fiscal policies, includ- (for example, loss in collateral value leads to a
ing the U.S. February 2009 stimulus package. tightening in lending conditions) and through
The figure shows confidence intervals for the ZIF.
four variables (the policy interest rate, infla- The euro area (second column) shows sig-
tion, growth, and the unemployment rate) nificantly less risk of deflation in the near term
in the three economies.2 The intervals were than the United States. In the baseline, inflation
derived using stochastic simulations, based on declines by much less, but rises more slowly.
the estimated historical distributions of all the As a result, the median path for the European
random factors in the model. The projection Central Bank (ECB) policy rate does not hit the
period in the figure is 2009:Q1–2011:Q4. ZIF exactly, but stays lower for longer because of
Results for the United States are shown in greater inertia in the economy. The probability
the first column of panels. The confidence that inflation will reach the ECB target of just
bands suggest a high probability that the under 2 percent by end-2010 looks fairly low.
federal funds rate will remain close to zero for Output shows a similar profile to the United
much of the next two years and a low prob- States, with a return to positive growth in 2010:
ability that it will rise above 2 percent over Q3. The median path for the unemployment
the three-year forecast horizon. Year-over-year rate reaches double digits, and again the confi-
inflation drops very sharply in early 2009, to dence interval is asymmetric, reflecting down-
negative numbers, largely as a result of falling side risks in the baseline.
energy prices. As the latter stabilize, the infla-
tion rate rebounds, but the median projection
3The model uses headline consumer price index
(at the center of the bands) remains close to
(CPI) in all countries. Based on past trends in relative
prices, a target range of 2–2.5 percent for headline
The main authors of this box are Kevin Clinton, CPI for the United States would be associated with a
Marianne Johnson, Ondra Kamenik, and Douglas 1.5–2 percent range for the core consumption defla-
Laxton. tor, a range that includes each Federal Reserve Board
1This box is based on Clinton and others Federal Open Market Committee (FOMC) member’s
(forthcoming). views of appropriate long-term inflation objectives. In
2The narrowest interval (darkest shading) is for January 2009 the Federal Reserve started to publish
the 0.1 confidence level; the wider intervals are for, FOMC members’ long-term forecasts to provide a bet-
respectively, the 0.30, 0.50, 0.70, and 0.90 levels. ter focal point for long-term inflation expectations.


Forecast Confidence Bands for the G3 Economies1

50th percentile 90, 70, 50, 30, 10 percent confidence bands

United States Euro Area Japan

Policy Rate (percent)

6 5 1.0
5 4 0.8
3 0.6
2 0.4
1 1 0.2

0 0 0.0
2007 08 09 10 11 11: 2007 08 09 10 11 11: 2007 08 09 10 11 11:
Q4 Q4 Q4
Consumer Price Index Inflation (percent change from a year earlier)
6 4 3
2 0
0 -1
-4 -2 -4
2007 08 09 10 11 11: 2007 08 09 10 11 11: 2007 08 09 10 11 11:
Q4 Q4 Q4
GDP Growth (percent change from a year earlier)
10 4 6
8 4
6 2
4 0 0
2 -2
0 -2 -4
-2 -6
-4 -8
-6 -6 -10
2007 08 09 10 11 11: 2007 08 09 10 11 11: 2007 08 09 10 11 11:
Q4 Q4 Q4
Unemployment Rate (percent)
14 14 8
12 7
10 11 6

8 10 5
6 4
4 7 3
2007 08 09 10 11 11: 2007 08 09 10 11 11: 2007 08 09 10 11 11:
Q4 Q4 Q4
Source: IMF staff estimates based on Global Projection Model.
1Clinton and others (forthcoming).


Box 1.3 (concluded)

Japan starts with significantly greater deflation level of fiscal stimulus (equivalent to about
risks than the United States or the euro area. 1 percent of GDP in 2011) yields outcomes in
Economic activity is very weak, and, apart from which the probability of hitting the ZIF is lower,
the energy-related spike in 2008, the inflation inflation is closer to target, and unemployment
rate has not been much above zero for many is lower (see Clinton and others, forthcoming).
years. Largely as a result, the policy rate is kept Moreover, the higher fiscal stimulus reduces the
at zero throughout the projection. The median risks in the unemployment outlook in that it
path for inflation remains negative, even after results in narrower, and more symmetric, confi-
energy prices stabilize, through 2010 and 2011. dence bands for unemployment.4
The median for the unemployment rate peaks
at about 5½ percent, which would be historically 4Models will often fail to converge under deflation

high for Japan. shocks, and this is the case for the current model
These projections are quite bleak, and since under various conditions. For example, a very low
the ZIF allows little, if any, room for further inflation target, or a high weight on actual inflation in
the expectations process, can result in deflation spirals.
interest rate reductions, they imply an argument This is more than a mere technical issue: it indicates a
for enhanced fiscal stimulus. It turns out that real risk that a deflation problem could become intrac-
simulations of the model for a common higher table in the absence of strong stabilizing policies.

ferentials in government bond spreads within about the U.S. fiscal trajectory. Such an event
the euro area have raised particular concern could prompt a sharp drop in the value of the
about how to handle a possible loss of market dollar, put strong upward pressure on other cur-
access by a sovereign borrower. In the emerging rencies viewed as safe havens, and give a further
economies, among the most affected have been jolt to financial market volatility. These concerns
countries with large external financing needs underline the importance of advancing credible
(for example, in emerging Europe), high risks medium-term fiscal consolidation plans in the
of financial and corporate stress as credit booms United States.
are unwound (for example, in central Asia), and
risks of widening fiscal deficits as commodity
revenues plummet (for example, in some South Exploring the Downside
American countries). Putting together the downside risks from
To date, sovereigns have avoided defaults, with macrofinancial linkages through the full range of
the singular exception of Ecuador. However, channels is a hugely complex task, even for a sin-
there could certainly be dangerous contagion gle country—let alone the global economy—and
effects spreading from a debt event in one is far beyond the capacity of any single economic
country to others with similar characteristics. model. But clearly the risks are large, as illus-
Moreover, rising concern about sovereigns under trated by the way macrofinancial interactions have
stress is reducing room to use fiscal policy as a already led to such an abrupt slowdown in activity
countercyclical tool to respond to weakening and have intensified stress since last September.
macroeconomic conditions in the short term, as A particular concern is that as the situation has
well as adding to sustainability concerns over the deteriorated, room for further macroeconomic
longer term if spreads do not narrow. Particu- policy support has dwindled—interest rates have
larly damaging to the global system would be an approached the zero bound, fiscal policy faces
abrupt loss in appetite for longer-term U.S. gov- rising concern about long-term sustainability, and
ernment bonds in the face of increasing worries reserve buffers are being depleted.


A downside scenario for the global economy Figure 1.12. Downside Scenario
is sketched in Figure 1.12, based on a simple (Percent change in output from a year earlier unless otherwise noted)
global macroeconomic model, to illustrate how,
With weak policy implementation, the global economy would be vulnerable to a
in the context of weak policy implementation, further intensification of negative macrofinancial feedbacks. The downside scenario
further demand shocks from macrofinancial presented here, based on a global macroeconomic model, represents the impact of a
variety of region-specific demand shocks and shows how the total impact on real
interactions could spill across borders to gener- GDP growth would be further magnified by trade linkages. See Appendix 1.3 for
ate an even deeper and more prolonged global additional details.

recession. This scenario corresponds broadly

WEO baseline Own demand shock only Full downside scenario
with the lower end of the 90 percent confidence
6 World World Output Gap 4
interval shown in the fan chart in Figure 1.10. (percent)
Although the links are not modeled explicitly, 4 2

these demand shocks would include tighter 0

restrictions on bank credit, falling asset and -2
commodity prices, deeper housing corrections, -4
and greater corporate distress.4 These shocks are -6
-4 -8
applied at a global level, although with different
intensity in different regions, consistent with the -6 -10
2008 09 10 11 11: 2008 09 10 11 11:
Q4 Q4
findings in Chapter 4 that high levels of stress
are quickly transmitted from advanced to emerg- 4
United States Euro Area
ing economies. The model assesses the impact 2
of trade linkages, showing the damage done to
output in emerging Asia in particular, where 0
the domestic demand shock has been relatively -2
mild. The central message from this scenario is -4
that the current global downturn could persist -6
much longer than in a normal business cycle. -6 -8
2008 09 10 11 11: 2008 09 10 11 11:
As illustrated, activity would continue to decline Q4 Q4
through 2010 before a recovery finally gets Japan Emerging Asia
4 10
under way in 2011. It would take many years to
reduce the large output gaps accumulated over 8
this period, which could rise to about 9 percent 6
at the global level by end-2010.
-4 4
Medium-Term Prospects beyond the
-10 0
Crisis 2008 09 10 11 11: 2008 09 10 11 11:
Q4 Q4
Although the precise length and severity of
the present global downturn remain highly 6 Latin America Emerging Europe 6

uncertain, it is not too soon to start looking 4 4

ahead to how the global economy and financial 2

system will emerge from the crisis and identify- 0
ing the forces that will shape the new landscape. -2
This section focuses on the difficult transition
-4 -6
ahead—covered by the World Economic Out-
-6 -8
2008 09 10 11 11: 2008 09 10 11 11:
Q4 Q4
4The shocks built into the downside scenario are

described in more detail in Appendix 1.3. Sources: WEO database; and model simulations.


look (WEO) five-year projection period—dur- how to strike the right balance between market
ing which damage now being done will need to incentives for risk taking and safeguarding sys-
be repaired and the world economy will need tem stability—is now the subject of intense study
to adjust to new realities. How this occurs will and review.5
be crucial to returning to a path of sustained Whatever the specifics, the process of restor-
global growth, rather than undergoing years of ing capital and trust, reducing leverage, and
lackluster performance, and has relevance for rebuilding institutions and markets will inevi-
policy design and implementation to deal with tably take considerable time—measured in
the present crisis. Although short-term needs years—during which credit availability is likely to
are paramount, stabilization will be hard if not remain seriously curtailed. Projections presented
impossible to achieve if policies do not provide in the April 2009 GFSR suggest that bank credit
a clear path to a more robust global economy in expansion in the major advanced economies will
the future. remain sluggish through the middle of the next
This section first looks at forces at play in decade. The recovery of securitization may also
four key areas: the global financial system and be gradual, since institutions and markets will
capital flows, public finances, private saving need to be redesigned and confidence rebuilt.
behavior, and productivity. It then considers Tighter credit discipline and the reduction of
how these drivers may interact to shape global leverage are likely to have a particular impact
economic prospects. on the availability and pricing of credit to riskier
borrowers, both firms and households.
These changes in the global financial system
Deleveraging Will Continue to Weigh on Credit will have important consequences for interna-
Creation and Capital Flows tional capital flows across a number of dimen-
A central challenge will be the restoration of sions. Greater constraints on leverage and a
healthy financial systems capable of providing stronger tendency for home bias are likely to
the credit needed for investment and growth continue to dampen gross cross-border flows in
while avoiding the excessive buildup of risk that the aggregate, after years of rapid growth. More-
led to the current crisis. Clearly, financial sys- over, tighter risk management and greater limits
tems will go through lengthy transition periods. on leverage should in principle reduce the ten-
After being propped up by massive government dency for surges in flows in response to short-
intervention, private capital must be rebuilt, gov- term opportunities and bring greater attention
ernment guarantees rolled back, and the expan- to long-run vulnerabilities. Both of these shifts
sion of central bank balance sheets unwound as would make it more difficult for countries to
confidence and trust are restored. At the same finance very large current account deficits or
time, it is now widely understood that regulation sustain overvalued exchange rates. At the same
of financial markets and institutions will need time, however, countries that have responded
to be overhauled to broaden the regulatory well in dealing with the current storms and
perimeter and bring all systemically impor- avoided the debt defaults experienced with sud-
tant institutions and markets under regulatory den stops in the past should gain credibility and
oversight, establish stricter control over leverage, be well placed to attract capital looking for an
and promote more robust risk management, attractive balance of risk and return.
while applying a macroprudential approach to
mitigate procyclical effects. Moreover, market
discipline will need to be strengthened through
5See the discussion in the April 2009 GFSR, as well as
improved transparency and more incentive-com-
other recent studies by the IMF (2009a, 2009b, 2009c,
patible compensation structures. How exactly 2009d, 2009f); Group of 30, 2009; and de Larosière
this should be achieved—and in particular Group, 2009.


Capital flows to emerging and developing

economies are projected to regain momentum
over the next five years, after a sharp drop in Figure 1.13. Net Capital Flows to Emerging and
2009, but to remain well below the peaks seen Developing Economies
(Percent of GDP)
in 2007 and 2008 (Figure 1.13). In fact, aggre-
gate net inflows are expected to be close to zero
Net capital flows to emerging and developing economies are projected to remain
or negative, since economies in Asia and the subdued for many years as global deleveraging continues. Emerging Asia and the
Middle East are expected to see significant outflows related to investment of current
Middle East would be capital exporters as cur- account surpluses, while other regions are generally expected to see much lower
rent account surpluses are invested elsewhere— rates of inflows than in recent years.
in emerging as well as mature markets. Flows to
countries in emerging Europe and the CIS are Private direct investment Private portfolio flows
Other private capital flows Official flows
expected to be less than half the rates observed Total
in recent years as a reaction to the vulnerabili-
ties involved with large-scale bank and portfolio 4 Total Emerging Asia 5
financing of current account deficits. Net flows 3

to Latin America and Africa will depend largely 3

2 2
on foreign direct investment.6
1 1
0 -1
Paths to Fiscal Consolidation -1 -2
Like financial systems, public finances will go -2
through difficult transitions over the next five -5
1990 95 2000 05 10 14 1990 95 2000 05 10 14
years. After jumping in 2009, fiscal deficits will
need to be consolidated to bring public finances
6 Latin America Emerging Europe 12
back on a sustainable trajectory, particularly with 10
looming demographic pressures on spending. 4 8
The feasible pace of fiscal consolidation will 6
depend to a considerable extent on the degree 2
to which economic growth is restored in 2010 2
and beyond. Fiscal deficits will inevitably remain 0

wide in 2010 as fiscal support continues to be -2 -2

provided to sustain still-fragile economic condi- -4

-4 -6
tions, but a return to more self-sustaining eco- 1990 95 2000 05 10 14 1990 95 2000 05 10 14
nomic growth thereafter would provide the basis
for a deliberate withdrawal of stimulus. The fis- 8 Africa Middle East 20

cal accounts should also benefit from improving 6 15

cyclical conditions and rising asset prices. 4 10
Even after building in consolidation, fiscal 2 5
prospects in the advanced economies cause seri-
0 0
ous concern, especially considering impending
-2 -5
pressures from population aging. In the baseline
projections, fiscal deficits in these economies -4 -10

are brought back to 4 percent by 2014. Even so, -6 -15

1990 95 2000 05 10 14 1990 95 2000 05 10 14

6However, gross portfolio and bank-related flows are Source: WEO database.
likely to rise more strongly than net flows, as investors in
emerging economies place funds offshore.


public debt would rise substantially, from about

75 percent of GDP in 2008 to almost 110 per-
cent by 2014 (Figure 1.14). And there are mul-
tiple downside risks: from a prolonged period of
slower growth (requiring greater fiscal stimulus)
and cyclical effects; from the possible greater
costs of fiscal support for the financial sector
(both because of new operations and possible
shortfalls from the returns on the management
Figure 1.14. General Government Fiscal Balances and and sale of assets acquired); from the possible
Public Debt need for public support to pension systems
(Percent of GDP) damaged by losses related to recent asset price
declines; and from rising real interest rates on
Fiscal consolidation will be a major challenge as the global economy starts to government debt as fiscal prospects deteriorate,
recover from the present crisis. Public debt is expected to continue mounting even
as deficits are reduced.
particularly if deflation becomes entrenched.
A recent IMF study suggests that the combined
Fiscal Balance 2 impact of such factors could raise the combined
government debt-to-GDP ratio in the advanced
economies in the G20 to 140 percent by 2014
-2 (IMF, 2009e).
Overall, fiscal prospects and risks seem some-
what better in emerging and developing econo-
Emerging and -6
developing economies mies, but individual economies could face sharp
Advanced -8 weakening of fiscal trajectories, particularly if
downside risks materialize. The most vulnerable
1970 80 90 2000 10 14 countries include those where financial and
corporate bailouts in response to crisis condi-
Public Debt 120
tions are allowed to cause a blowout in public
100 debt and those that allowed public spending to
economies balloon in years of high revenues (often related
to rocketing commodity prices) and do not rein
60 in spending in accordance with more modest
40 commodity price prospects. On the other hand,
Emerging and
developing economies in some economies fiscal prudence could be
reinforced by a desire to rebuild policy buffers
0 against future global shocks.
1970 80 90 2000 10 14

Source: WEO database projections.

Private Sector Challenges and Responses
Turning from the public to the private sector,
the global economy faces a protracted period
of higher private saving in the advanced econo-
mies. As explored in Box 2.1, households have
been battered by a steep loss in financial wealth
and, in a number of countries, by reductions in
housing wealth. Moreover, tighter restrictions
on credit availability and leverage and concerns


about high unemployment are likely to weigh

on consumption for some time. Although the
recent jump in precautionary saving is likely
to subside as the global economy finds a more Figure 1.15. Global Saving, Investment, and
secure footing, private saving is still projected to Current Accounts
be sustained at rates substantially higher than (Percent of world GDP)
in the past decade, notably in economies like
Private saving is likely to remain elevated in the years ahead, as households in
the United Kingdom and the United States, advanced economies repair balance sheets and emerging economies adjust to
where households had previously relied largely weaker prospects for capital inflows.

on wealth accumulation through capital gains

rather than net savings out of income (Fig- Private saving Investment
Public saving Current account (left scale)
ure 1.15). Corporate saving will also likely rise,
as businesses look to restore balance sheets after All Economies 28

the severe downturn, and borrowing constraints 24

imply that retained earnings are likely to be the 20

dominant source of funding for investment. 16

In the emerging economies, tighter financial 12
constraints are expected to weigh on prospects 8
for investment and income convergence. This 4
is most clearly the case for emerging Europe, 0
which had previously relied on large inflows -4
1990 95 2000 05 10 14
of foreign savings to finance rising investment.
More moderate prospects for commodity prices, 0.8 Advanced Economies 28
as well as financing constraints, may also lead to 24
a scaling back of investment plans in oil export-
0.0 20
ers and other commodity-rich economies (see
Box 1.5 in Appendix 1.1).
-0.8 12
With investment constrained, a key issue is
whether countries will be able to compensate
-1.6 4
with improved investment efficiency (or faster
growth of total factor productivity) in order to
-2.4 -4
sustain potential growth rates. This occurred 1990 95 2000 05 10 14
to a degree after the Asian crisis, as east Asian
countries were able to achieve strong growth 6.0 Emerging and Developing Economies 40

despite lower rates of investment (see Chapter 4.5 32

3 in the September 2006 World Economic Out-
3.0 24
look). The challenge is likely to be greater in the
years ahead, however, as growth will probably be 1.5 16
more focused in sectors geared toward meeting
0.0 8
domestic demand, where productivity gains are
expected to be slower than in export sectors -1.5 0

heavily involved in manufacturing. Success in -3.0 -8

1990 95 2000 05 10 14
restoring credit flows subject to market disci-
pline will be essential to ensure that resources Source: WEO database projections.
are well allocated: reliance on funding from
retained earnings would likely mean less effi-
cient investment allocation. Productivity growth


will also depend on sustained product and labor integration of the global economy (including,
market reforms and continued integration into for example, completion of the Doha Round of
global markets. Conversely, any tendency toward world trade negotiations). Global growth would
rising trade or financial protectionism would return to robust rates, allowing output gaps to
have a negative impact. be closed more quickly and providing room for
more rapid fiscal consolidation in the United
States and elsewhere. Global imbalances would
Alternative Paths Depend on Policy Choices be reduced as a depreciating dollar continues
Considering these various forces, the global to lower the U.S. current account deficit, while
economy will face the challenge of sustaining Asian surpluses moderate.
aggregate demand to absorb excess capacity In the downside scenario, adjustment is
while avoiding the reemergence of asset price slower, reforms are sidetracked, and growth
bubbles. More restrained demand for global sav- prospects are subdued. Fiscal consolidation is
ings by countries that previously had run large slower, unemployment remains elevated for lon-
external deficits (whether housing-led consump- ger, deflation risks remain a concern, and creep-
tion booms in advanced economies or commod- ing trade and financial protectionism hamper
ity- or capital-inflow-fueled booms in emerging productivity growth. Moreover, in these circum-
economies) could put downward pressure on stances, global imbalances would remain wide,
world real interest rates. This tendency could implying a further buildup in U.S. indebtedness
be amplified to the extent that economies seek to the rest of the world and higher risks of an
to replenish reserve stockpiles through tight eventual disorderly unwinding, particularly if the
macroeconomic policies or competitive advan- sustainability of the U.S. fiscal position comes
tage by limiting exchange rate appreciation. into question. Thus, although global imbalances
Countervailing tendencies would result if slow may not have been the central driving force
fiscal consolidation means sustained high public behind the current global crisis, concerns in this
borrowing, if fast-growing economies in Asia area remain pertinent, especially if the global
that account for a rising share of global GDP are crisis leads to a permanent decline in gross
able to shift smoothly from external to internal cross-border capital flows (see Box 1.4).
sources of demand through a sustained increase
in consumption, and if the advanced economies
are able to restore the financial system’s capacity Policies to End the Crisis while Paving
to extend credit and to push forward ambitious the Way to Sustained Recovery
reforms to support productivity growth. The difficult and highly uncertain short-term
Alternative paths for the global economy are outlook underlines the need for policymakers to
illustrated in Figure 1.16, based on the IMF act decisively to deal with a severe global reces-
staff’s Global Integrated Monetary and Fiscal sion that has taken on dangerous dimensions
Model. The simulations show a benign scenario despite wide-ranging efforts. The immediate
and a downside scenario. In the benign sce- imperative is to move boldly with credible plans
nario, policies foster a successful rebalancing to deal with the financial crisis that has been at
of the global economy. Key ingredients include the core of the global recession over the past
stronger consumption growth in east Asia along- six months. Past episodes of financial crisis have
side an appreciating real effective exchange shown that delays in tackling the underlying
rate facilitated by more flexible exchange rate problems mean a more prolonged economic
management, successful implementation of downturn and ultimately a greater burden on
plans to rebuild effective financial interme- the taxpayer. At the same time, macroeconomic
diation at both the national and international policies must continue to be geared as far as
levels, and advances toward financial and trade possible to supporting demand to minimize fur-


Figure 1.16. Alternative Medium-Term Scenarios

(All variables in levels; years on x-axis)

Alternative scenarios for the global economy, based on the Global Integrated Monetary and Financial (GIMF) Model, illustrate how favorable policies would promote
stronger and more balanced global growth.

Benign scenario Downside scenario

World United States Euro Area Emerging Asia

GDP Growth (year over year; in percentage points)
10 5 5 15

5 10
0 0
0 5

-5 -5 -5 0
2006 08 10 12 14 2006 08 10 12 14 2006 08 10 12 14 2006 08 10 12 14
Government-Deficit-to-GDP Ratio (in percentage points)
8 15 8 6

6 6 4
4 4 2
2 2 0

0 0 0 -2
2006 08 10 12 14 2006 08 10 12 14 2006 08 10 12 14 2006 08 10 12 14
Private-Savings-to-GDP Ratio (in percentage points)
25 25 20 42

24 20 19 40

23 15 18 38

22 10 17 36
2006 08 10 12 14 2006 08 10 12 14 2006 08 10 12 14 2006 08 10 12 14
Current-Account-to-GDP Ratio (in percentage points)
0 1 8

0 6
-1 4

-10 -2 2
2006 08 10 12 14 2006 08 10 12 14 2006 08 10 12 14
U.S. Dollar Exchange Rate (in percent; + = depreciation)
2 0.9 110

0.8 100
0.7 90

0 0.6 80
2006 08 10 12 14 2006 08 10 12 14 2006 08 10 12 14

Source: GIMF simulations.


Box 1.4. Global Imbalances and the Financial Crisis

As policymakers begin to ponder the causes crisis and its savings soared (Bernanke,
and lessons of the financial crisis, the topic of 2005); the rise in the U.S. fiscal deficit and
global current account imbalances has once a decline in U.S. household savings (see
again become an issue: Chapter 3 of the April 2005 World Economic
• To what extent did global external imbal- Outlook); and emerging Asia’s export-led
ances contribute to the financial crisis? development, relying on undervalued
• Has the crisis changed the outlook for global exchange rates and reserve accumulation
imbalances? (Dooley, Folkerts-Landau, and Garber, 2004).
• Do global imbalances remain a concern? • Other explanations centered around long-
These questions are explored in this box. It term structural factors. In particular, the
concludes that although global imbalances may attractiveness of U.S. financial assets, owing
have been a factor behind the buildup of mac- to their perceived high liquidity and sophis-
roeconomic and financial excesses that led to ticated investor protection, created sustained
the crisis, the crisis was largely caused by weak demand for U.S. assets (Blanchard, Giavazzi,
risk management in large institutions at the and Sa, 2005; Caballero, Farhi, and Gourin-
core of the global financial system combined chas, 2008; and Cooper, 2008).
with failures in financial regulation and super- Many authors expressed concern that contin-
vision. Despite earlier concerns, a disorderly ued widening of imbalances implied an unsus-
exit from the dollar has not yet been part of tainable buildup in external claims on the deficit
the crisis narrative. Looking ahead, imbalances countries, particularly the United States, which
are projected to moderate but will remain a would eventually need to be unwound through a
source of policy concern. substantial dollar depreciation, possibly in a dis-
orderly fashion (see Chapter 3 of the April 2005
Origin of the Imbalances World Economic Outlook; and Obstfeld and Rogoff,
The phrase “global imbalances” refers to the 2005, 2007). In 2006–07, major governments
pattern of current account deficits and sur- agreed to implement wide-ranging policies to
pluses that built up in the global economy start- redistribute the pattern of global demand to
ing in the late 1990s, with the United States moderate these risks, in the context of a Mul-
and some other countries developing large tilateral Consultation coordinated by the IMF
deficits (United Kingdom; southern Europe, (IMF, 2007).2 Yet other observers took a more
including Greece, Italy, Portugal, and Spain; sanguine view, emphasizing that imbalances
central and eastern Europe), and others large could be sustained as long as the structural fac-
surpluses (notably, China, Japan, other east tors supporting them remained in place.
Asian economies, Germany, and oil export-
ers).1 Multiple explanations were put forward to Imbalances and the Crisis
rationalize this rise in imbalances: Some predictions concerning the unwinding
• Some authors emphasized macroeconomic of global imbalances did materialize during
policy factors: the “global savings glut” as the early stages of the financial crisis. Even
Asia cut back on investment after the Asian
2For the United States, to take steps to boost
national saving, including fiscal consolidation; for
The main authors of this box are Charles Collyns Europe and Japan, to implement growth-enhancing
and Natalia Tamirisa, with input from Gian Maria structural reforms to boost domestic demand; for
Milesi-Ferretti and assistance from Ercument Tulun. emerging Asia, to boost domestic demand and allow
1The global distribution of current account imbal- currencies to appreciate; and for Saudi Arabia, to
ances widened over past four decades, suggesting that boost domestic demand by increasing fiscal spending
countries were generally running larger deficits and consistent with absorptive capacity and macroeco-
surpluses (Faruqee and Lee, 2008). nomic stability (IMF, 2007).


before the crisis, the U.S. (non-oil) current

account deficit started to narrow on the back
of past dollar depreciation and a slowing of the U.S. Current Account Deficit and Its Financing
U.S. economy relative to its trading partners
(Milesi-Ferretti, 2008). The collapse of the U.S. 115 United States: Real Effective Exchange Rate (REER) 8
and Current Account Deficits1
subprime mortgage market in August 2007 110
and a further deceleration of the U.S. economy 105 (left scale, index- 6

driven by the housing market correction has- 100 2000 = 100)

tened the adjustment in the U.S. non-oil trade 95
balance, although rising oil prices weighed on 90 Current account balance 2
the oil balance. In the meantime, shocks to the 85
(inverted, right scale,
U.S. subprime and mortgage-based securities percent of GDP)
80 0
markets further weakened the dollar—by about 1995 97 99 2001 03 05 07 08:
8½ percent in real effective terms between June
Net Official and Private Capital Flows to and from 12
2007 and July 2008 (first figure, top panel). Yet the United States
the scenario that some had feared—a broad- (percent of GDP) 9

based flight from U.S. assets and a sudden drop 6

in the value of the dollar—did not occur, in 3

part because a flight to safety in the context of 0
intensifying global financial turmoil prompted -3
a surge in demand for U.S. government securi- Direct investment -6
ties. The dollar has rebounded strongly since -9
2000 01 02 03 04 05 06 07 08:
September 2008, as the crisis deepened and Q4
increasingly engulfed other economies.
Net International Purchases of U.S. Bonds 350
Thus, a reversal of capital inflows to the (billions of U.S. dollars) 300
United States and the depreciation of the dol- 250
lar clearly were not the trigger for the current 200
global crisis. The shock, rather, came from a 100
reversal of the overoptimistic assessment of risk 50
on U.S. subprime and other mortgage-backed 0
Corporate bonds -50
assets, which prompted a massive increase in Agency bonds
Treasury bonds -100
risk aversion, a loss of financial capital, and -150
2000 01 02 03 04 05 06 07 08:
deleveraging. It is not surprising that the Q4
effects of this immense financial shock were Private Flows of Foreign and U.S. Investors to 800
also different from a currency crisis. and from the United States
(billions of U.S. dollars) 600
Indeed, the composition of U.S. asset hold- Foreign private
ings in countries’ sectoral balance sheets has assets in the U.S. 400

played a key role in how the crisis has spread to 200

other countries. Overseas holdings of U.S. toxic 0
assets were concentrated in highly leveraged U.S. private
financial institutions in advanced economies assets abroad
such as France, Germany, Switzerland, and the -400
2000 01 02 03 04 05 06 07 08:
United Kingdom (U.S. Treasury and Federal Q4
Reserve, 2008). When the value of these assets Sources: Haver Analytics; U.S. Treasury; and IMF staff
declined with the onset of the crisis, the finan- 1Based on consumer price index.

cial sectors of these countries became affected,


Box 1.4 (continued)

ment in financial institutions and weakness in

Global Imbalances, Liquidity, and U.S. House financial supervision and regulation.
Prices In any event, the financial crisis accelerated
the adjustment of global current account imbal-
180 10
ances. Three channels are playing a key role in
Base money plus reserves this process:
(right scale)
8 • an increase in private savings, owing to the
unwinding of housing and credit bubbles
120 Global in the United States, with a partly offsetting
imbalances1 6
U.S. house price index decline in public savings;
100 (right scale)
(left scale)
• a tightening of global credit conditions,
80 owing to deleveraging in the financial sec-
tor, particularly in the United States, partly
2 offset through the easing of monetary policy,
40 liquidity provision, and bank rescue mea-
20 0
sures; and
1990 92 94 96 98 2000 02 04 06 08 • an improvement in the terms of trade, owing
to a decline in oil prices for oil-importing
Sources: Haver Analytics; and IMF staff calculations.
1Absolute sum of current account balances in percent of world countries, with opposite effects for oil-
GDP. exporting countries.
Reflecting these factors, the World Economic
Outlook (WEO) summary measure of global
even though their current account imbalances imbalances is projected to decline abruptly
were not necessarily large. from 5¾ percent of world GDP in 2007 to about
With the benefit of hindsight, a more 4 percent in 2009, driven by a reduction in
nuanced view is emerging of the role of global the current account imbalances in the United
imbalances in the buildup of systemic risk in States, oil-exporting countries, and, to a lesser
the run-up to the crisis (IMF, 2009a). Global extent, Japan (third figure, bottom panel).4 The
imbalances were an integral part of the global U.S. current account deficit, in particular, is
pattern of low interest rates and large capital set to narrow from a peak of 6 percent of GDP
inflows into U.S. and European banks, which in 2006 to about 3¼ percent of GDP in 2009
in turn fostered a buildup of leverage, a search (third figure, top panel). Current accounts are
for yield, and the creation of riskier assets also contracting sharply in other countries, with
and house price bubbles in the United States large deficits as credit booms are reversed (for
and some other advanced economies (second example, southern Europe and United Kingdom
figure).3 But a central role in the current crisis among the advanced economies, and central and
has been played by the failure of risk manage- eastern Europe among emerging economies).
Dramatic declines in financial asset prices
caused by the crisis have had a strong impact
3Caballero and Krishnamurthy (2008) develop a on countries’ net external positions (Milesi-
model linking increased demand for U.S. assets to Ferretti, 2009). In particular, the U.S. net
rising leverage and securitization in the U.S. financial external position is projected to deteriorate
system. The link was more complicated in practice: from about 4½ percent of global GDP in 2007
official investors from emerging economies tended
to buy agency debt, whereas private investors from
advanced economies were buying mortgage-backed 4The summary measure is defined as the absolute

securities that were not supported by guarantees from sum of current account imbalances, in percent of
the government-sponsored enterprises. world GDP.


to about 9 percent of global GDP in 2009 (third

figure, middle panel). A significant portion
Current Account Balances and Net Foreign of the deterioration that has already taken
Assets place represents valuation losses, mostly on
(Percent of global GDP) foreign equity holdings, and the remainder
is the financing of the U.S. current account
United States Euro area deficit. Economies that have experienced cor-
Japan Oil exporters1
Emerging Asia 2 responding gains on their external positions
are the euro area and emerging economies
Current Account Balance 2.0
(for example, Brazil, Russia, India, and China).
1.5 Given large foreign holdings of domestic stocks
1.0 in these economies, the collapse of domestic
0.5 stock markets has led to significant reductions
0.0 in domestic residents’ liabilities to foreigners.
April 2008 WEO -0.5 Patterns of financing for the U.S. current
-1.0 account deficit have also changed as a result
April 2009 WEO -1.5 of the crisis. From the beginning of the crisis
-2.0 to the third quarter of 2008, official purchases
1997 99 2001 03 05 07 09 11 13
dominated as private inflows declined sharply
Net Foreign Assets 12 (first figure, second panel). In the second
half of the year, however, net official flows to
6 the United States decreased, largely owing to
drawings on temporary swap lines between
0 the U.S. Federal Reserve and foreign central
banks, while private inflows rose because U.S.
-6 residents repatriated capital from abroad.
April 2008 WEO
April 2009 WEO Since September 2008, foreigners have been
-12 unloading U.S. agency bonds (first figure,
1997 99 2001 03 05 07 09 11 13
third panel). Purchases of U.S. Treasury bonds
Global Imbalances 8 remained strong through the third quarter
(absolute sum of current account balances in of 2008, when foreigners started to shift away
percent of world GDP) April 2008 WEO
6 from purchasing U.S. Treasury bonds toward
U.S. Treasury bills, in part owing to their
4 increased issuance. This trend continued
April 2009 WEO through the end of the year. More generally,
2 however, private capital flows have plummeted
during the crisis, pointing to a sharp increase
1970 75 80 85 90 95 2000 05 10 14 in home bias—that is, the share of private sav-
ings invested domestically rather than abroad
Sources: Lane and Milesi-Ferretti (2006); and IMF staff (first figure, bottom panel).
1Algeria, Angola, Azerbaijan, Bahrain, Republic of Congo,
Ecuador, Equatorial Guinea, Gabon, Islamic Republic of Iran, Post-Crisis Outlook for Imbalances
Kuwait, Libya, Nigeria, Norway, Oman, Qatar, Russia, Saudi
Arabia, Syrian Arab Republic, Turkmenistan, United Arab Emirates, The evolution of imbalances in the com-
Venezuela, and Republic of Yemen. ing years will depend critically on how policy
2China, Hong Kong SAR, Indonesia, Korea, Malaysia,
Philippines, Singapore, Taiwan Province of China, and Thailand. responses to the crisis and post-crisis reforms
affect the long-term saving and investment
behavior of the private and public sectors.


Box 1.4 (concluded)

According to current WEO baseline projec- have not gone away. The financing of current
tions, global imbalances are set to stabilize over account deficits, particularly in the United
the medium term, with the summary measure States, may still be problematic in the coming
of imbalances settling at about 4 percent of years. If the attractiveness of U.S. assets were to
world GDP (third figure, bottom panel). The decline, for example, because foreigners became
U.S. current account deficit is expected to concerned that higher government financ-
remain broadly stable at about 3¼ percent of ing needs would push up U.S. long-term bond
GDP during 2010–11, owing to the effects of yields, foreign investors might reduce their U.S.
the crisis fiscal stimulus, and then resume a exposure, leading to an abrupt depreciation of
declining trend, reaching 2¼ percent of GDP the dollar. Another possibility, closely related
by 2014 (third figure, top panel). However, to the structural explanations of global current
surpluses in Asia are projected to continue account imbalances, is that the financial crisis
to widen gradually over the medium term, may lead to a lasting increase in home bias and
and the crisis-related drop in oil exporters’ a decline in cross-border gross capital flows. This
surpluses will partially unwind. The U.S. net may reduce the availability of financing for the
external position will also continue to deterio- U.S. current account deficit as well as current
rate, as U.S. external borrowing needs remain account deficits of many emerging and develop-
substantial (third figure, middle panel). ing economies that benefited from financial glo-
Thus, concerns about global imbalances balization during the decades prior to the crisis.

ther corrosive feedback from weakening activity solutions that foster a healthy financial system
onto the financial sector. This task will become that is less prone to boom-and-bust cycles but
increasingly challenging since the conventional still capable of its primary task of efficient inter-
weapons have already been deployed and the mediation of savings and investment. Moreover,
deepening downturn may put a damper on the short-term effectiveness of macroeconomic
further actions in many countries. policies will depend on medium-term credibil-
These policy challenges are amplified—and ity. Exit strategies will be needed to transition
given added urgency—by the global nature of fiscal and monetary policies from extraordinary
the crisis. Economies will not be able to rely short-term support to sustainable medium-term
on exports as an escape route, as they could frameworks.
in the Asian crisis or as Japan did in the 1990s
(see Chapter 3). Moreover, policymakers must
be mindful of the cross-border ramifications of Financial Sector Policies—Dealing with the Core
policy choices. Initiatives that support trade and of the Problem
financial partners—including fiscal stimulus Decisive progress toward the restoration of
and official support for international financing financial sector stability and market trust is the
flows—will help bolster global demand, with critical prerequisite for arresting the downward
shared benefits. Conversely, a slide toward trade momentum of the global economy and paving
and financial protectionism would be hugely the way for an enduring recovery. Systematic
damaging to all, a clear warning from the expe- and proactive approaches have started to sup-
rience with 1930s beggar-thy-neighbor policies. plant ad hoc interventions, but markets remain
Policies must also be guided by a medium- to be convinced that financial sector policies
term compass. It will be critical to find financial will be effective, which undermines the impact


of the monetary and fiscal policy stimulus now to lift the broader uncertainty clouding banks’
in train. Moreover, to the extent that financial portfolios. An alternative with a proven track
market strains are global and policy actions record is to remove impaired assets from
have cross-border spillovers, international policy financial sector balance sheets, moving them
cooperation is crucial for restoring market into publicly owned asset management compa-
trust. nies (also known as “bad banks”). Purchases by
There are three key elements of a strat- public-private partnerships, as proposed in the
egy to restore financial institutions to health: United States, could also be used as a means to
(1) ensuring that financial institutions have remove troubled assets in a transparent manner,
access to liquidity, (2) identifying and dealing but these need to be structured in a way that
with distressed assets, and (3) recapitalizing encourages participation by both buyers and
weak but viable institutions. The first area is sellers on terms consistent with resources avail-
being addressed forcefully, but policy initiatives able under the program. In general, different
in the other two areas need to advance more approaches can work, depending on country
convincingly. circumstances, and the priority is to choose an
The critical underpinning of an enduring approach, ensure that it is adequately funded,
solution must be credible loss recognition. and implement it in a transparent and consis-
Uncertainty about the valuation of troubled tent manner.
assets continues to raise concerns about the Recapitalization efforts must be based on
viability of financial institutions, including a careful evaluation of the long-term viability
those that have received government support. of financial institutions, taking into account a
Policymakers must require that assets be valued realistic assessment of likely losses on problem
conservatively, transparently, and consistently assets, the quality of capital and management,
across institutions. Although the lack of liquid- and business prospects. Supervisors will need
ity and their complex structure make it difficult to establish an appropriate level of regulatory
to precisely value many impaired assets, gov- capital for institutions, taking into account regu-
ernments need to establish methodologies for latory minimums and the need for buffers to
realistically valuing illiquid securitized credit absorb further unexpected losses. Viable banks
instruments based on realistic expectations of with insufficient capital should then be quickly
future income streams.7 Such valuation should recapitalized, with capital injections from the
ideally be applied consistently across countries government accompanied by private funds, if
to avoid regulatory arbitrage or competitive possible, to achieve a level sufficient to restore
distortions. market confidence in the bank. Given the deep-
Limiting further losses from distressed assets ening of the crisis, governments should be pre-
can be achieved in different ways but is likely pared to provide capital in the form of common
to require substantial public support and must shares as the best means to improve confidence
be transparent to be convincing. Ring-fencing and funding prospects, even if this implies tem-
troubled assets on balance sheets and providing porary government majority ownership.8 Nonvi-
partial public guarantees can be done quickly able institutions should be intervened promptly,
with minimal upfront fiscal costs, but efforts leading to orderly resolution through closure
to do so in recent months have not improved
market confidence, and this approach is unlikely 8Although permanent public ownership of core bank-
ing institutions would be undesirable from a number
of perspectives, there have been numerous instances
7Recent proposals provided by the International (for example, Japan, Korea, Sweden, United States) of
Accounting Standards Board and the Basel Committee a period of public ownership being used to cleanse bal-
regarding disclosure and fair value practices offer useful ance sheets and pave the way for the banks’ resale to the
guidance in this regard. private sector.


or merger. To avoid further systemic effects, the the risks related to sudden stops of private
authorities will need to be cognizant of the legal capital flows.
conditions under which intervention may be Measures to deal with financial distress must
considered “insolvency” and thus a credit event also be mindful of transition problems and the
for the purpose of triggering default clauses in future contours of the financial system. Current
credit default swap contracts. Institutions operat- actions should be consistent with a long-term
ing with government capital should be carefully vision of a healthy, efficient, and dynamic finan-
monitored, with restrictions on dividend pay- cial system. Achieving these objectives requires
ments and scrutiny of executive compensation steps to limit moral hazard and to develop exit
policies. The amount of public funding required strategies from large-scale public interventions,
is likely to be large—considerably more than has including to ensure a smooth transition back
been put on the table so far—but the require- to private intermediation in dislocated markets.
ments for public support are likely to continue Lower leverage and a smaller financial sec-
rising the longer the solution is delayed. tor are inevitable, and current actions should
Greater international cooperation is needed not impede the necessary restructuring of the
to avoid exacerbating cross-border strains. system as a whole. Regulatory standards should
Disparities in the degree of support afforded be strengthened—consistent with the systemic
to financial institutions in different countries risks posed by institutions—but changes should
have created additional strains and distortions. be introduced gradually after recovery is assured
It is important to provide greater clarity and to avoid aggravating adverse feedback with the
consistency to the rules applied to valuation of real economy.
troubled assets, guarantees, and recapitalization The difficult task of restoring the financial
in order to avoid unintended consequences system to health must be supported by actions to
and competitive distortions—whereby domestic facilitate borrower restructuring to mitigate the
institutions or local credit provision is favored to destruction of value associated with disorderly
the detriment of others. liquidations. A key challenge has been to find
The need for a broader international ways to facilitate mortgage modifications in the
approach is particularly relevant for emerg- United States to reduce the damaging wave of
ing economies. As emphasized previously and foreclosures that has added to the downward
in the April 2009 GFSR, emerging European momentum in the U.S. housing market. Recent
economies have been particularly vulnerable initiatives that commit public funds to improve
to disruptions in credit flows because of their incentives for both borrowers and lenders to
large external financing needs and may have participate and facilitate write-downs of princi-
been adversely affected by financial support pal through personal bankruptcy procedures
measures in western Europe aimed at safe- should help deal with this problem, and similar
guarding the position of domestic banks. There approaches may be needed in other countries.
is an urgent need to establish clear guidelines Another area of strain is the wave of corporate
for cross-border crisis management and burden failures likely in the period ahead, especially
sharing, to support the continued availability in the emerging economies where companies
of credit lines, and to provide needed emer- are exposed to high rollover risks on external
gency external financing. In parallel, recent financing and have limited domestic alternatives
reforms to increase the flexibility of lending and where the legal framework and capacity
instruments for good performers caught in bad for restructuring may be limited. Authorities
weather together with plans advanced by the in a number of countries have already taken
G20 summit to increase the resources available steps to support credit flows through guarantees
to the IMF are enhancing the capacity of the and back-stop facilities, and direct government
international financial community to address support for corporate borrowing may be war-


ranted. In addition, plans should be readied for intermediation. In the current circumstances,
large-scale restructuring in case circumstances such approaches may be particularly effective if
deteriorate further. Experiences with the after- they help unlock illiquid or disrupted markets—
math of the Asian crisis suggest that a com- so-called credit easing (Bernanke, 2009). Such
prehensive rather than piecemeal approach to a strategy extends the “quantitative easing” used
debt workouts can help ensure that large-scale by the Bank of Japan in 2001–06, where the
corporate restructuring occurs in an orderly focus was on boosting commercial bank reserves
fashion, including through consensual private through government bond purchases.
involvement. In pursuing credit easing, central banks
should structure their activities in a way that
maximizes relief in dislocated markets—increas-
Monetary Policy—Turning to Unconventional ing credit availability and lowering spreads—
Approaches while minimizing possible longer-term collateral
Inflation fears are a fast-receding memory, damage. To the extent possible, credit allocation
and central bankers around the world are now decisions should be left with private financial
on the front lines in the fight to sustain demand intermediaries, rather than taken over by the
in the face of financial disruptions. In advanced central bank. Moreover, credit risk that is not
economies, the task is magnified by the rising retained in the private sector should be covered
threat of deflation and the constraint of the zero by national treasuries rather than allowed to
interest rate floor. In such circumstances, it is jeopardize central bank balance sheets. Consid-
crucial to act aggressively to counter deflation eration should also be given to how the extraor-
risks. Although policy rates are already near dinary credit operations would be unwound.
the zero floor in many countries, policy room Support provided in the form of short-term
still remains in some regimes (such as the euro liquidity facilities can be quickly reversed when
area) and should be used quickly. There seems market conditions eventually normalize, but
little risk of overdoing monetary easing in the operations involving longer-maturity assets could
current circumstances. At the same time, clear be harder to unwind.
communication is important—central bankers These points are also relevant to central banks
should underline their determination to avoid in emerging economies. However, in many of
deflation by sustaining easy monetary conditions those economies, the central bank’s task is fur-
for as long as it takes, while making clear their ther complicated by the need to sustain external
long-term commitment to avoiding a resurgence stability in the face of highly fragile financ-
of inflation. ing flows. To a much greater extent than for
Nonetheless, the firepower from conven- advanced economies, emerging market financ-
tional policy instruments is unlikely to be ing is subject to dramatic disruptions—sudden
sufficient—the zero floor constrains room for stops—in part because of greater concerns
further cutting, and the impact of lower policy about the creditworthiness of the sovereign.
rates is reduced by credit market disruptions. In Emerging economies also have tended to bor-
these circumstances, lowering interest rates will row more heavily in foreign currency, so large
need to be supported by increasing recourse to exchange rate depreciations can do severe dam-
less conventional approaches, using both the age to their balance sheets.
size and composition of the central bank’s own Thus, although most central banks in these
balance sheet to support credit intermediation. economies have lowered interest rates in the
As discussed previously, many central banks have face of the global downturn, they have been
already introduced an array of new instruments, appropriately cautious in doing so in order to
including purchases of long-term government maintain incentives for capital inflows and to
securities and more direct measures to support avoid disorderly exchange rate moves or a full-


blown capital account crisis. To some degree, war changes and should be a central element of the
chests of international reserves have provided policy response.9
ammunition to counter volatile exchange rate
movements and sustain the availability of foreign
currency funding, but as time has passed, these Fiscal Policy—Stimulus with Sustainability
reserve stockpiles have been depleted, leaving In view of the extent of the downturn and
less room to maneuver. Countries facing par- the limits on monetary policy’s effectiveness,
ticularly difficult external conditions—including fiscal policy must play a crucial part in provid-
large current account deficits to be financed, ing short-term support to the global economy.
large rollover requirements, a reliance on fragile Indeed, a key finding of Chapter 3 is that in the
interbank flows, and dwindling reserves—may context of a financial crisis, fiscal policy can be
have to tighten monetary policy to preserve particularly effective in shortening the duration
external stability, despite adverse consequences of recessions, whereas the impact of monetary
for domestic activity. Access to official financ- policy is reduced. However, room to provide
ing—including both regional and bilateral credit such fiscal support will be limited if such efforts
lines and contingent financing from the IMF— erode credibility in the absence of a medium-
can play an important part in reducing such term framework. Thus, governments are faced
painful trade-offs. with a difficult balancing act—delivering short-
Turning to the post-crisis world, a key chal- term expansionary policies but also providing
lenge will be to calibrate the pace at which to reassurance for medium-term prospects.
withdraw the extraordinary monetary stimulus This task is becoming increasingly difficult as
now being provided. Acting too quickly would the downturn extends in depth and duration.
risk undercutting what is likely to be a frag- Although governments have acted to provide
ile recovery, but acting too slowly could risk substantial stimulus in 2009, it is now apparent
a return to overheating and new asset price that the effort will need to be at least sustained,
bubbles. In some cases, achieving a smooth if not increased, in 2010, and countries with
transition may call for new instruments, such as fiscal room should stand ready to introduce new
allowing central banks to issue their own paper stimulus measures as needed to support the
to soak up excess liquidity. recovery. As far as possible, this should be a joint
These choices will arise in the context of effort since part of the impact of an individual
the broader issue of whether the approach to country’s measures will leak across borders but
monetary policy should be extended to more brings benefits to the global economy.
explicitly encompass macrofinancial stability as It is thus welcome that most G20 coun-
well as price stability, and if so, how this should tries—emerging as well as advanced—have
be done. It is now painfully clear that asset price contributed to the fiscal efforts. However, the
booms fed by leveraged financing and involving task of sustaining stimulus is becoming more
financial intermediaries need to be dealt with difficult as some countries face increasing limits
forcefully, since they threaten to undermine on their fiscal room from market concerns
the credit supply and the economy. Although about the sustainability of their public finances.
regulatory policy must play a central part in This is particularly true for emerging econo-
controlling such risks, monetary policy cannot mies with less developed fiscal institutions, less
neglect booms in asset prices and credit and secure financing, and downgraded medium-
should respond to unusually rapid asset price
movements or signs of asset market overshoot-
9These issues are discussed further in IMF (2009c). See
ing, particularly in the context of credit booms.
also Chapter 3 of the October 2008 World Economic Outlook
Prudential measures provide a more targeted
for a discussion of how monetary policy could be adapted
and less costly policy solution than interest rate to give greater weight to house prices in particular.


term growth prospects. But it is also true for an dealing with the fiscal challenges posed by aging
increasing range of advanced economies, where populations. The costs of the current financial
trajectories for the public accounts show a major crisis—although sizable—are dwarfed by the
buildup in debt, particularly those that also face impending costs from rising expenditures on
heavy bills for financial sector cleanup and aging social security and health care for the elderly
populations. (IMF, 2009e). Credible policy reforms to these
How to alleviate the tension between stimu- programs may not have much immediate impact
lus and sustainability? One key is the choice on the fiscal accounts but could have an enor-
of stimulus measures. As far as possible, these mous effect on fiscal prospects and thus could
should be temporary and maximize “bang for help preserve fiscal room to provide short-term
the buck.” Typically, this argues for steps to fiscal support.
raise spending on specific projects and time-
bound tax cuts that focus on improving the
cash flow of credit-constrained households.10 It Global Responses Will Be Critical
is also desirable to target measures that bring In the face of a crisis of global dimensions, a
long-term benefits to an economy’s productive global response will be essential to drive turn-
potential (and hence tax-raising capacity). For around and recovery. The preceding discus-
both these reasons, initiatives to boost infra- sion has already outlined a range of areas
structure spending are particularly helpful at where cooperative efforts across countries are
the current juncture. In a normal business cycle, indispensable.
such spending often arrives just as the need for • Measures to deal with financial stress and
it diminishes, but in the present cycle, a higher restore financial viability must be coordinated
level of spending will be needed over a num- internationally to reduce cross-border spill-
ber of years. In principle, this can be done by overs and generate coherent resolution of
advancing planned projects, thus leaving the net financial institutions that are often global in
present value of spending unchanged. character. Creeping financial protectionism
Second, governments need to complement should be avoided.
initiatives to provide short-term stimulus with • The provision of fiscal stimulus to sustain
reforms to strengthen medium-term fiscal global demand should be a joint effort, with
frameworks. Relevant areas include tax reform countries with the most fiscal room playing
to reduce reliance on asset-price-linked tax the lead role, again in recognition of cross-
revenues, measures to improve transparency border implications.
and oversight of government spending, and • Monetary and credit policies should also be
steps to provide robust medium-term budgetary geared toward supporting demand as far as
frameworks to deliver consolidation in periods possible but should avoid seeking to engineer
of strong growth as well as room to ease up dur- competitive currency depreciation that would
ing downturns. Reforms in these areas would be be futile from a global perspective.
valuable across the advanced economies but are • Similarly, countries must be careful to resist
even more important in emerging economies the temptation to slip toward protectionist
where fiscal management systems are far less measures on the trade front.
developed. • Sources of official financing support should
Third, probably the greatest contribution be strengthened so that countries facing pres-
to improving credibility of fiscal sustainability sure to finance current account deficits can
would be to make concrete progress toward avoid unnecessarily harsh adjustments that
would also spill across borders.
10See, for further elaboration on these issues, Spilim- • Better early-warning systems and more open
bergo and others (2008) and IMF (2009e). communication of risks would help provide


a stronger basis for international policy indicating a stronger-than-expected downturn in

collaboration. activity in advanced, emerging, and other devel-
Global cooperation will also be important in oping economies in mid-2008. These develop-
paving the path to prosperity as the world seeks ments defied earlier expectations that emerging
to rebuild after the crisis. Completion of the and developing economies would remain resil-
Doha multilateral trade round would provide a ient to slowing growth in advanced economies.
boost to the global trade integration that is at Because these economies had accounted for the
the center of productivity growth. The task of bulk of incremental demand during the boom,
rebuilding the financial regulatory framework, near-term demand prospects in global com-
to better control and guarantee stability while modity markets became less promising. Another
providing for efficient financial intermediation, reason for the turnaround was the demand
must be a multilateral endeavor. Similarly, a decline in advanced economies. Although these
more flexible system of currency management economies only accounted for a small share of
across all the world’s major economies would the demand increases during the boom, they
support more fluid rebalancing of global sup- have accounted for most of the fall in the levels
ply and demand to underpin the process of of global commodity consumption in recent
convergence of income levels. Increasing the months.
availability of international financial resources The sharp deterioration in global growth
that can be tapped in adverse market conditions prospects associated with the global financial
and providing greater flexibility in terms of such turmoil during September and October 2008
credits would help limit a continued push to led to accelerated downward price adjustment
self-insurance and a massive buildup of offi- through November. Commodity prices broadly
cial international reserves. Finally, aid flows to stabilized in December. Since then, prices have
low-income countries need to be protected and mostly fluctuated within a range, with several
built up to prevent the required fiscal retrench- so far short-lived rallies for some commodities,
ment in donor countries in the years ahead notably oil and more recently base metals.
from jeopardizing progress toward eliminating The impact of the global slowdown has varied
global poverty. across commodities. Following past cyclical pat-
terns, commodities closely tied to the manu-
facturing of investment and durable goods and
Appendix 1.1. Commodity Market construction—particularly fuels and base met-
Developments and Prospects als—have been most affected. The impact of the
The authors of this appendix are Kevin Cheng, slowdown on food prices was markedly milder
To-Nhu Dao, Nese Erbil, and Thomas Helbling. than for other commodities, given the lower
income elasticity of underlying demand. Nev-
Financial turmoil and a sharp deterioration in ertheless, with declining pressure from energy
global economic prospects in the third quarter costs and biofuel demand—two key factors
of 2008 abruptly ended the commodity price during the price run-up—the price response of
boom of the past few years. The price correc- food commodities to the downturn was stronger
tion was sharp and rapid, with the magnitude than usual.
of price changes and volatility rising to unprec-
edented levels for many major commodities
(Table 1.2). By December, the IMF commodity How Has Financial Stress Affected Commodity
price index had declined by almost 55 percent Markets?
from its July peak (Figure 1.17, top panel). Besides the indirect impact through the real
The start of the turnaround in commodity economy, commodity markets were also directly
prices broadly coincided with incoming data affected by the escalation of the financial crisis


in September. Investors unwound commodity

asset positions for the same reasons that led to
the general disorderly deleveraging discussed in
this chapter. First, many commodity investment Figure 1.17. Commodity and Petroleum Prices
instruments are over-the-counter (OTC) prod-
Commodity Price Indices 450
ucts (such as total return swaps anchored on (January 2003 = 100) Energy
commodity index returns) that involve counter- 350
party risks. Second, some highly leveraged com- 300
modity investment positions had to be unwound raw materials Food

because of refinancing difficulties. Third, more Beverages 200

generally, as commodity financial markets
remained relatively liquid compared with some 50
2003 04 05 06 07 08 09 10
other asset markets, commodity positions were
liquidated as investors sought to increase their 1
320 Exchange-Traded Funds and Assets under Management 320
holdings of safe assets.11 (billions of dollars, in terms of 2005:Q1 real prices) 280
The strength of the unwinding of commodity Commodity index swaps Exchange-traded
240 240
Commodity medium- commodity products
investment in the second half of 2008 is difficult term notes 200
ETF trade volume index 160
to quantify, given the lack of data and the fact 160 (right scale, 2005:Q1 = 1)
that a good part of the reduction in the notional 120 80
value of commodity positions reflected declines 80 40
in commodity prices. At the level of commod- 40 0
2005 06 07 08 09:
ity assets under management, the reduction in Q1
positions in real terms (adjusted by the IMF
Noncommercial Net Long Positions 2
commodity price index) seems to have been 150 300
(thousands of contracts; quarterly averages)
relatively minor (Figure 1.17, second panel). 250
However, there was a marked shift from OTC Oil Wheat Copper 200
commodity index positions to exchange-traded 50 150
funds and structured products (medium-term 100
notes). On U.S. commodity futures exchanges, 0
Gold 50
there was a noticeable reduction in overall open (right scale)
-50 0
interest between July and November, includ- 2008 09: 2008 09: 2008 09: 2008 09:
Q1 Q1 Q1 Q1
ing of noncommercial participants. Since then,
there has been some pickup in open interest.
Average Petroleum Spot and Futures Prices 140
On balance, this evidence points to a rela- (U.S. dollars a barrel)
As of July 24, 2008 120
tively short period of marked unwinding of com-
modity positions from September to November. As of April 30, 2008
As a result, liquidity in commodity futures mar- 80

kets declined, which contributed to the sharp 60

As of April 14, 2009
increase in price volatility at the time.12 With 40

2003 05 07 09 11 Dec.
11In addition, the effective appreciation of the U.S. 13
dollar since fall 2008 has also played a role. As discussed
Sources: Barclays Capital; Bloomberg Financial Markets; and IMF staff estimates.
in Box 1.1 in the April 2008 World Economic Outlook, U.S. 1Deflated by IMF Commodity Index.
dollar shocks can have a significant impact on prices of 2At the Chicago Board of Trade, New York Mercantile Exchange and Commodity
nonperishable commodities, particularly crude oil and Exchange, respectively.
12Some investors, notably hedge funds, have direct

exposure to commodity futures markets. There can


Table 1.2. Comparison of Commodity Price Volatility

(Weekly; in percent)
Six-Month Change Standard Deviation1
Largest Largest six-month decline during Highest during
six-month decline 1970–20072 1970–20072 Average during
in 2008 (year) 2008 (year) 1970–20072
Crude oil (WTI)3 –76.8 –60.1 (1986) 18.4 16.1 (1999) 8.5
Aluminum –52.9 –33.4 (1991) 12.1 8.9 (1994) 5.6
Copper –54.8 –52.6 (1974) 12.2 13.0 (1974) 6.7
Nickel –68.0 –49.0 (1990) 23.6 17.7 (2006) 9.2
Corn –52.4 –51.8 (1997) 13.9 13.6 (1988) 7.6
Wheat –45.2 –38.0 (1996) 16.0 12.9 (2007) 6.4
Soybeans –44.1 –51.3 (2004) 12.8 15.5 (2004) 6.3
Gold –25.4 –30.1 (1981) 8.7 13.3 (1979) 5.1
Sources: Datastream; and IMF staff calculations.
1Standard deviation of weekly changes in commodity prices over a 12-month period.
2Data beginning in 1983–2007 for crude oil; 1988–2007 for aluminum; and 1979–2007 for nickel, corn, wheat, and soybeans. With increased

financial turmoil in September–October, the price decline accelerated.

3WTI = West Texas Intermediate.

the pickup in investor interest since December, prices to rise in the future. This “contango”
however, the large-scale unwinding of com- constellation, which has been observed in other
modity positions ended, and the main channel recent episodes of cyclical demand weakness,
through which financial factors affect prices now provides incentives for inventory accumulation.
is through their impact on activity and global Commodity prices are expected to remain
demand for and supply of commodities. subdued as long as global activity continues to
slow but then to pick up on more definitive
signs of a turnaround. There is some upside
When Will Commodity Markets Rebound? potential from supply retrenchment, notably
Commodity markets are now in a phase of from production cuts in less competitive markets
cyclical weakness. Demand has softened rapidly, or adverse weather conditions, as inventory
while the supply response to falling prices has levels for some major food staples are still low by
been slow, resulting in rising inventories. In this historical standards. On the downside, although
period of adjustment, spot prices have generally strong declines in demand for commodities are
declined much more than futures prices, and already reflected in current prices, prices would
futures curves for major commodities have been likely decline further in the event of a much
upward sloping, suggesting that markets expect deeper than expected global downturn.
A key question is whether commodity prices
will recover in the medium term. As discussed
be indirect effects on futures demand or supply from
commodity financial investment more generally because
in Box 1.5, the main factors that have supported
financial intermediaries tend to hedge their exposure high commodity prices in recent years—con-
to OTC commodity derivative positions, including those tinued rapid increases in commodity demand
of institutional investors, through offsetting positions in
from emerging economies and the need to
futures markets. In view of these linkages between com-
modity investment and futures markets, financial flows tap higher-cost sources of supply—are likely to
can have short-term price effects. However, there is no reemerge in the context of a sustained global
compelling evidence of a sustained price impact of com- recovery. Even so, prices are unlikely to rebound
modity financial investment. These issues are discussed
in more detail in Box 3.1 in the October 2008 World quickly to the very high levels seen in 2007
Economic Outlook. or the first half of 2008. Global growth is not


Box 1.5. Will Commodity Prices Rise Again when the Global Economy Recovers?

Since the commodity price collapse in the an oligopolistic supply structure, concentrated
second half of 2008, price prospects have been reserves, and luxury characteristics (car owner-
widely debated. On the one hand, strongly ship is a key driver of consumption).
upward-sloping futures curves for many major The first figure also suggests that long-term
commodities point to prices rising over the trends often are not a good guide to medium-
next few years. These “contango” constellations term price fluctuations.2 Average rates of
are consistent with the view that prices will change, for example, vary considerably by
rebound when the global economy recovers, decade. The trend component in commodity
because of renewed sharp increases in com- prices shifts over time, reflecting changes in
modity demand from emerging economies and longer-run price determinants, such as aver-
the need to open up more costly supplies. age costs of marginal fields or mines. How
On the other hand, spot prices remain important are the fluctuations in the trend
under downward pressure, given still-weak- component relative to those in the cyclical com-
ening demand and rising inventories. With ponent? If fluctuations in the latter dominated,
a protracted global slowdown increasingly longer-term trends would provide useful signals.
likely, prospects for a rapid commodity price If not, past trends would provide little guidance.
rebound seem remote, reminiscent of past A simple way to gauge the relative importance
episodes when commodity prices experienced of these two components is to compare the
long slumps after short booms.1 volatility of spot and futures prices. The latter
To evaluate commodity price prospects, are predictors of future spot prices. The cyclical
this box analyzes the information content of component should therefore be discounted
futures prices and past trends and examines in futures prices, with the discount increasing
how the interplay between global growth with the maturity of futures contracts. In other
and commodity demand over the downturn words, the volatility in longer-term futures
and the recovery affects the likelihood of a contracts should largely reflect the volatility of
rebound in commodity prices. markets’ view of the trend component.
As shown in the first table, futures price
Will Prices Resume Their Trend Decline? volatility is lower than spot price volatility for
Over very long horizons, prices for many four major commodities—crude oil, aluminum,
commodities have declined relative to those copper, and wheat. At the one-year horizon, for
of manufactures and services (first figure). example, the ratio of futures to spot volatility
The secular declines reflect relatively strong ranges between 0.6 for wheat and about 0.9 for
productivity gains in the commodity-extracting copper. However, although it decreases with
sectors and the fact that many commodities the maturity of the futures contract, the ratio
are necessities—their share in total consump- remains relatively high. Even at the five-year
tion declines as income increases. Within this horizon, futures volatility is still about one-half
broad picture, rates of decline vary greatly that of spot prices,3 and in the past few years,
by commodity, depending on factors such as relative futures price volatility has risen. These
available reserves in the case of nonrenew- results imply that fluctuations in the trend
able resources, industry structure, and specific components account for a substantial share of
demand characteristics. Oil is the main commodity price fluctuations. They also suggest
exception to the rule of decline—reflecting that the current levels of the trend components

The main authors of this box are Kevin Cheng and 2See Pindyck (1999), Cuddington (2007), and

Thomas Helbling. Cashin and McDermott (2002), among others, on

1See, for example, Cashin, McDermott, and Scott trends and cycles in commodity prices.
(2002). 3Five-year contracts for wheat are not available.


Box 1.5 (continued)

Spot and Futures Price Volatility
(Standard deviations of daily price changes; in percent)
Futures Prices Trends and Cycles in Commodity Prices
(In logs; in terms of U.S. Consumer price index)
Three- One- Two- Five-
Spot month year year year
Real Oil Price 3
Crude oil (WTI1)
1998–2008 8.6 7.9 6.0 5.1 4.7 2
1998–2003 8.4 7.5 4.3 2.9 2.5
2004–08 8.8 8.4 7.5 6.8 6.5 1
1998–2008 4.6 4.4 3.7 3.2 3.3 0
1998–2003 3.5 3.2 2.4 1.8 0.5 Cycle1
2004–08 5.7 5.5 4.8 4.2 3.7 1900 20 40 60 80 2000
1998–2008 7.0 6.9 6.3 6.0 6.8 Real Metal Prices 4
1998–2003 4.2 4.2 3.6 3.3 2.7
2004–08 9.4 9.3 8.6 8.1 7.5 3
Wheat 2
1998–2008 8.1 21.6 5.1 4.0 —
1998–2003 5.9 21.3 3.6 2.2 — Cycle1 1
2004–08 10.2 22.1 6.5 5.1 — 0
Sources: Bloomberg Financial Markets; and IMF staff
calculations. 1900 20 40 60 80 2000
1WTI = West Texas Intermediate.

Real Nonfood Agricultural Commodity Prices 3

(shown in the first figure), which remain rela-
tively high despite the recent price corrections, 1
are subject to considerable uncertainty.
How Reliable Are Futures Curve Signals?
1900 20 40 60 80 2000
A related question is whether the slope of
the commodity futures curve provides a useful Real Food Commodity Prices 3
signal for the direction of future commod- Trend
ity price changes. Evidence from past global 2

downturns suggests that it should. 1

During periods of weak global demand and
declining spot prices, futures curves were typi- 0
cally upward sloping, implying that prices are
expected to recover in the cyclical upswing.4 1900 20 40 60 80 2000

Such a constellation of current and expected

Sources: Grilli and Yang (1988); Pfaffenzeller, Newbold, and
future spot prices also provides an incentive Rayner (2007); Bloomberg; and IMF staff calculations.
1 Deviations from trend (in logs).
for inventory accumulation to absorb the
excess supply (production minus consump-
tion) of commodities, which is often observed
in downturns. The reason is that the expecta-
tion of higher future prices and the associated
returns from price appreciation provide an
4There are other reasons futures curves can be par-
incentive for inventory accumulation during a
tially or fully upward sloping, including higher future
inflation or expectations of supply shortages.
downturn, since other benefits (for example,


Success Ratios of Price Forecasts Based on Futures When Will Commodity Demand Recover?
Considering the case for a return to high
Crude commodity prices from a fundamental perspec-
Oil2 Aluminum2 Copper2 Wheat3
tive, the key question is whether and, if so, how
12-month futures4 fast the interplay of demand and supply factors
1990:M1–2008:M11 0.84
will again lead to supply-constrained market
conditions. With demand now below produc-
1998:M1–2008:M11 0.81 0.88 0.93 0.65
[0.00] [0.00] [0.00] [0.00] tion and inventories rising, this will significantly
24-month futures4
depend on demand prospects. Although the
1998:M1–2008:M11 0.87 0.88 0.89 0.68 supply side also matters, it is less likely to be a
[0.00] [ 0.00] [0.00] [0.00] constraint in the early stages of the next global
Sources: Bloomberg Financial Markets; and IMF staff expansion. The reason is that despite the
calculations. postponement of some capital expenditures,
1Fraction of periods for which the futures-spot spread

correctly predicted the direction of actual price changes over the especially on new projects, investment is likely
following 12 or 24 months. Values in square brackets denote the to decrease only gradually. Spending on large
statistical significance of the success ratios (see text for details). investment projects that have been in train for
2New York Mercantile Exchange.
3Chicago Board of Trade. some time will continue, given the high costs
4Last observation of the month. of project delays or, even more so, shutdowns.
As a result, although producers may seek to
curtail actual output—which may limit price
from precautionary motives) tend to decrease declines—capacity will continue to increase
at the margin as inventories increase. 5 into the downturn. In a global recovery, spare
To assess the reliability of the futures curve capacity and inventories can then absorb rising
slope as a predictor, so-called success ratios for demand in the early stages, and price increases
price forecasts were computed for crude oil, will primarily reflect the cyclical rebound in
aluminum, copper, and wheat based on cur- costs and margins rather than rents from capac-
rent 12-month and 24-month futures spreads ity contraints.
(second table).6 The ratio measures how often To assess demand prospects, simple dynamic
these spreads between futures and spot prices demand equations were estimated for the same
correctly predict the direction of actual price four commodities analyzed above—aluminum,
changes for these four commodities. Thus, copper, crude oil, and wheat.7 These equations
over a 12-month horizon, the current West were then used to predict demand under the
Texas Intermediate crude oil spread correctly assumption of prices remaining at current low
predicted the future price changes 84 per- levels for three global growth scenarios—the
cent of the time. Typically, these ratios are World Economic Outlook (WEO) baseline
statistically significant—that is, they predict and two alternative scenarios, for high and
the direction of change more often than they low growth (growth at one standard deviation
would if the futures price had no significance above or below the baseline rate). To allow for
in predicting future spot prices. In sum, the heterogeneity across countries, equations are
current contango constellation provides useful estimated for three different country groups—
signals for a cyclical recovery in commodity advanced economies, major emerging and
prices. developing economies—Brazil, Russia, India,

7The equations include real GDP, the relative price

5SeePindyck (2001), among others, on inventory of the commodity, lagged consumption of the com-
and commodity price dynamics. modity, and dummy variables to account for structural
6See Pesaran and Timmermann (1992). breaks.


Box 1.5 (concluded)

and China—and other emerging and develop-

ing economies.
Demand Growth Projections for Major
Commodities1 Using annual data for 1970–2008, the results
(Annual percent change) suggest the following:
High growth Baseline • Among the four commodities, demand for
Low growth 2006–07 average aluminum and copper respond most strongly
Aluminum 16
to GDP changes, with the income elasticities
12 typically exceeding 1. For crude oil, income
8 elasticities are smaller than those for metals
and are typically below 1. For wheat, income
-4 elasticities are virtually zero in all country
-8 groups. From a demand perspective, market
-12 conditions should therefore tighten first in
1980– 90– 2000– 06 08 10 12 metals markets.
89 99 05
• The model predicts that with unchanged
Copper 8
prices, aluminum demand growth will
Average 4 rebound to the high average rates of 2006–
0 07 by 2010 in the high-growth and baseline
cases (second figure). In the low-growth
scenario, which would represent a more
-8 protracted global downturn, demand growth
1980– 90– 2000– 06 08 10 12
-12 would remain below the 2006–07 average
89 99 05 through 2013.
Crude Oil 8 • In the case of copper and crude oil, average
growth during 2006–07 would be reached again
4 in 2011 in the baseline scenario and by 2010
in the high-growth scenario. In the low-growth
scenario, demand growth would again remain
-4 below recent average rates through 2013.

• Comparing the implied path for oil demand
1980– 90– 2000– 06 08 10 12 with capacity estimates suggests that in the
89 99 05
high-growth scenario, spare capacity would
Wheat 6 again fall to the average level of 3 million bar-
4 rels a day over 1989–2008 by 2010 and reach
2 recent lows by 2011. In the baseline scenario,
spare capacity would decrease more gradually.
• The model predicts that wheat demand will
remain relatively buoyant in any scenario,
-4 suggesting that wheat prices may remain
1980– 90– 2000– 06 08 10 12
89 99 05 high throughout the downturn.
Source: IMF staff estimates. In sum, the scenarios highlight how the
1 The charts show projected demand growth under the
assumption of unchanged prices. The baseline scenario is based strength of demand depends on the timing and
on the April 2009 WEO projections for regional growth; the buoyancy of a global recovery. If the recovery
high- and low-growth scenarios assume GDP growth paths at
plus or minus one standard deviation around the baseline case. is late or sluggish, the demand rebound will be
slow, and capacity constraints are unlikely to put
upward pressure on prices before 2012–13.


expected to recover to the rapid pace achieved Although demand growth decelerated in
in 2003–07 anytime soon since the financial cri- 2008, production through the third quarter of
sis will have lasting effects on credit and capital the year was markedly above levels recorded in
flows. Spare capacity has risen rapidly, and more 2007, largely because of increased Organization
capacity is likely to come onstream, suggest- of Petroleum Exporting Countries (OPEC) pro-
ing that the need for additional capacity will duction. On an annual basis, global oil produc-
emerge later and more gradually than previously tion increased by 0.9 mbd in 2008, double the
assumed. increase recorded in the previous year.
Non-OPEC production fell short of projec-
Oil Markets tions once again in 2008. Unlike in the past few
Among the main primary commodity mar- years, when production was simply slowing, non-
kets, oil markets have been most affected by the OPEC output actually fell throughout the year
rapid decline in global activity since the third relative to production levels recorded in 2007,
quarter of 2008 and the sharp deterioration in as declines in the North Sea and in Mexico were
near-term global prospects. After peaking at an not offset by higher production elsewhere, given
all-time record high (in both nominal and real sluggish investment in real terms.
terms) of $143 a barrel on July 11, oil prices OPEC production was some 1.2 mbd above
collapsed to about $38 by end-December.13 levels in the previous year through the third
Since then, prices have broadly stabilized in the quarter of 2008. Subsequently, OPEC decided to
$40–$50 range, with some recent upticks beyond reduce production quotas, in response to weak-
that range (Figure 1.17, fourth panel). ening oil demand, by a total of 4.2 mbd a day
The turnaround in oil prices last year coin- by January 2009. Although production cuts were
cided with a turnaround in global oil demand implemented beginning in October, the impact
(Table 1.3). Although oil consumption had risen on average production in the fourth quarter
by some 0.8 million barrels a day (mbd) in the was relatively small (–0.6 mbd). By March 2009,
first half of 2008 (year over year), it turned in the reduction in OPEC production from the
the third quarter and fell by 2.2 mbd (year over September base level was estimated at 4.0 mbd,
year) in the fourth quarter. On an annual basis, some 95 percent of the target. In the past, the
global oil demand fell by 0.4 mbd in 2008, the compliance rate after six months amounted
first decrease since the early 1980s, compared to about 66 percent. With these production
with an expected increase of 1 mbd just some cuts, and so much new capacity having come
nine months previously. The decline in global onstream in 2008, OPEC spare capacity was
oil demand was entirely attributable to sharply estimated at 6.7 mbd in March, almost twice the
decelerating demand in advanced economies (a average level of the past 10 years.
decline of 1.7 mbd compared with a decline of With higher production and falling demand,
0.4 mbd in the previous year), particularly in the the supply-demand balance turned around
United States (1.2 mbd) and Japan (0.4 mbd). decisively in 2008. On average, supply exceeded
Oil demand in emerging and other developing demand by 0.7 mbd, implying substantial inven-
economies continued to increase through 2008, tory accumulation at the global level. In terms
albeit at a slowing pace in all regions but the of actual inventory data, inventory in Organiza-
Middle East. tion for Economic Cooperation and Develop-
ment (OECD) countries started rising noticeably
in the second half of 2008, particularly in the
United States (Figure 1.18, third panel). Reflect-
13Unless otherwise stated, oil prices refer to the IMf’s
ing this easing of broad market conditions (see
Average Petroleum Spot Price, which is a simple average
of the prices for the West Texas Intermediate, dated below), the futures price curve has moved from
Brent, and Dubai Fateh grades. the usual backwardation to strong contango, a


constellation that is consistent with incentives

for building inventory.
Figure 1.18. World Oil Market Developments Near-term price prospects depend on the
interplay between likely further declines in
8 Semiannual World Oil Consumption 100
(millions of barrels a day; year-over-year change on left scale) both demand and supply. On an annual basis,
United States Emerging and developing economies the International Energy Agency forecasts that
4 China Other advanced economies 90 global demand will decline by about 2.4 mbd
2 in 2009, largely because of further decreases in
0 80 OECD demand. If March 2009 production lev-
-2 Total consumption els were maintained through 2009, OPEC pro-
(right scale)
-4 70
duction would be some 3.2 mbd below average
2004 05 06 07 08 09: 2008 levels. Non-OPEC supply is likely to drop
slightly in 2009, as low oil prices have not only
Semiannual World Oil Capacity and Production1
(millions of barrels a day; year-over-year change on left scale)
100 increased incentives to delay or defer invest-
Saudi Arabia Other non-OPEC countries ment spending but have also reduced incentives
8 CIS Other OPEC countries 2
90 for spending on field maintenance (to slow
Total capacity down the fields’ natural decline). In the aggre-
(right scale)
gate, supply is therefore likely to fall more than
0 demand, and oil market tightness is expected
to reemerge in 2009. High inventory levels will
-4 70 provide some cushion initially, but this will not
2004 05 06 07 08 09:
H2 be lasting. As a result, prices are expected to
OECD Inventory Demand Forward Cover 62 stabilize and rise moderately during the second
Actual 60 half of 2009.
3 58 In the medium term, oil prices are likely to
Averages 2003–07
56 rebound further, although a rapid recovery
54 to the record price levels seen in the first half
52 of 2008 is unlikely, given prospects of more
50 moderate growth in emerging and develop-
48 ing economies in the next global expansion.
2004 05 06 07 Jan.
09 Supply constraints in the oil sector, however,
Expected West Texas Intermediate Crude Oil Prices as of April 14, 2009 200
could emerge sooner than for other nonrenew-
(U.S. dollars a barrel) Futures
50 percent confidence interval able commodities, given the adverse effects of
70 percent confidence interval 160
90 percent confidence interval
the financial market crisis and low oil prices on
120 capital expenditures.14 Although lower invest-
ment and maintenance spending is a general
trend across nonrenewable commodities, its
40 implications for oil capacity may be more severe
0 because of the relatively high field decline rates
2007 08 09 10 Dec.
11 in recent years. Adequate investment and main-
Sources: Bloomberg Financial Markets; International Energy Agency; U.S. Energy
tenance spending is therefore needed to sustain
Information Agency; and IMF staff estimates. current production capacity.
1 CIS is the Commonwealth of Independent States. OPEC is the Organization of
Petroleum Exporting Countries.
2 Includes OPEC natural gas liquids.
3 Band is based on averages for each calendar month during 2003–07 and a 40 percent
confidence interval based on deviations during this period.
4 From futures options. 14Box 1.5 in the April 2008 World Economic Outlook

discusses the reasons for the sluggish supply response to

high oil prices during the recent oil price boom.


Table 1.3. Global Oil Demand and Production by Region

(Millions of barrels a day)
Year over Year Percent Change
2008 2008
2003–06 2009 2007 2009
Average 2007 2008 Proj. H2 H1 H2 2007 2008 Proj. H1 H2
OECD1 49.4 49.2 47.5 45.3 49.4 48.1 47.0 –0.8 –3.4 –4.9 –1.9 –4.8
North America 25.2 25.5 24.3 23.3 25.5 24.7 23.9 0.4 –4.8 –4.2 –3.4 –6.3
of which
United States 20.9 21.0 19.9 19.0 20.2 19.5 19.5 0.0 –5.6 –4.4 –7.3 –3.7
Europe 15.6 15.3 15.2 14.6 15.5 15.0 15.4 –2.4 –0.6 –4.0 0.0 –1.1
Pacific 8.6 8.3 8.0 7.3 8.3 8.3 7.7 –1.6 –3.8 –8.9 –0.6 –7.1
Non-OECD 33.5 36.9 38.2 38.3 37.1 38.2 38.1 3.8 3.5 –0.1 4.3 2.7
of which
China 6.5 7.5 7.9 7.8 7.6 7.9 7.8 4.6 4.3 –0.8 5.0 3.6
Other Asia 8.7 9.3 9.4 9.4 9.2 9.6 9.1 2.8 1.4 –0.6 3.8 –1.1
Former Soviet Union 3.9 4.1 4.2 4.1 4.2 4.1 4.3 1.6 2.3 –2.9 2.4 2.2
Middle East 5.8 6.5 6.9 7.2 6.6 6.8 7.0 4.7 6.4 2.5 5.9 6.8
Africa 2.8 3.1 3.1 3.2 3.1 3.2 3.1 3.8 2.1 0.9 2.4 1.8
Latin America 5.0 5.6 5.9 5.9 5.7 5.8 6.0 5.4 4.4 –0.1 5.1 3.8
World 82.8 86.0 85.7 83.4 86.5 86.3 85.1 1.1 –0.4 –2.8 0.8 –1.6
OPEC (current composition)2 33.6 34.9 35.9 — 35.3 36.0 35.8 –0.9 3.0 — 4.7 1.4
of which
Saudi Arabia 10.2 10.0 10.4 — 10.1 10.4 10.4 –4.4 4.2 — 5.4 3.0
Nigeria 2.5 2.3 2.2 — 2.4 2.1 2.2 –4.8 –7.9 — –8.0 –7.9
Venezuela 2.8 2.6 2.6 — 2.6 2.6 2.6 –7.8 –1.2 — –0.5 –2.0
Iraq 1.8 2.1 2.4 — 2.2 2.4 2.4 9.9 14.0 — 23.9 5.5
Non-OPEC 49.8 50.7 50.6 50.3 50.5 50.8 50.3 0.8 –0.2 –0.7 –0.2 –0.3
of which
North America 14.4 14.3 13.9 13.9 14.2 14.1 13.8 0.1 –2.3 0.1 –1.7 –2.8
North Sea 5.4 4.6 4.4 3.9 4.5 4.4 4.3 –5.0 –4.8 –10.7 –5.5 –4.1
Russia 9.4 10.1 10.0 9.7 10.1 10.0 10.0 2.4 –0.8 –2.5 –0.8 –0.9
Other former Soviet Union 2.1 2.7 2.8 2.8 2.7 2.9 2.7 12.1 2.5 1.5 6.5 –1.6
Other non-OPEC 18.6 19.1 19.5 19.9 19.1 19.4 19.6 0.4 2.3 1.6 1.7 2.9
World 83.4 85.5 86.5 — 85.8 86.8 86.1 0.1 1.1 — 1.8 0.4
Net demand3 –0.6 0.5 –0.8 — 0.7 –0.5 –1.0 — — — — —
Sources: Oil Market Report, International Energy Agency (April 2009); and IMF staff calculations.
1OECD = Organization for Economic Cooperation and Development.
2Includes Angola (subject to quotas since January 2007) and Ecuador (rejoined Organization of Petroleum Exporting Countries, OPEC, in

November 2007, after suspending its membership during December 1992–October 2007).
3Net demand is the difference between demand and production. It includes a statistical difference. A positive value indicates a tightening of

market balances.

Other Energy Prices Natural gas prices have followed different

Other energy markets were also disrupted trends across major regions. In the United
by the downturn. Coal prices had by end-2008 States, prices fell by more than 50 percent
fallen by more than 50 percent from their from their summer 2008 highs. Although
record high in July (Figure 1.19, top panel), residential consumption held up as a result
given declining demand for power and from of colder weather, industrial and power sec-
steel production across the globe. On the sup- tor demand weakened significantly. Given a
ply side, major coal producers have begun to robust supply and reduced exports to Asia,
cut production, but inventories are still rising. natural gas inventories in the United States


rose above recent five-year-average levels. In

contrast, European natural gas prices contin-
Figure 1.19. Developments in Metal and Energy Markets ued to rise during the second half of 2008,
reflecting supply disruptions related to the
Prices of Energy Commodities 140 disputes between Russia and Ukraine against
(U.S. dollars a barrel of oil equivalent) Oil
120 the backdrop of limited capacity for storage
100 and imports of liquefied natural gas.
Australian coal
U.S. gas 60
Metal Prices
European gas 40 After surging to record highs last spring,
20 metal prices fell rapidly during the second
1992 94 96 98 2000 02 04 06 Mar.
0 half of 2008, with prices of key metals—alu-
09 minum, copper, and nickel—losing more
450 Selected Metal Prices 1 60 than half of their peak values (Figure 1.19,
400 (January 2006 = 100) Futures spread
Nickel (percent, end-year; 50 second panel). Prices of some metals have
Lead right scale) somewhat recovered more recently—notably
300 Copper 40
250 those of copper and zinc, which rose by more
200 than 20 percent during the first quarter of
150 20
2009. But prices of others have declined,
Aluminium 10 with those of aluminum falling by more than
2006 07 08 09 10 11 12 13
0 10 percent during the same period.
The sharp deceleration in industrial pro-
World Copper and Aluminum Consumption Growth by Regions 8 duction and construction in major emerg-
(millions of metric tons) 7 ing economies, notably China—the largest
United States Emerging and developing economies
China Other advanced economies
5 consumer of major metals—has taken a
3 heavy toll on metal demand (Figure 1.19,
2 third panel). On the supply side, prices that
0 are approaching or falling below marginal
-1 costs and tightening credit conditions have
-3 prompted producers to reduce output and
2000 01 02 03 04 05 06 07 08
scale back investment. Nevertheless, supply
4400 Metal Inventories and Prices 2 240 retrenchment lagged demand declines, with
Metal price index, 2005 = 100

4000 Metal price index metal inventories doubling in 2008 relative to

Thousand metric tons

3600 Inventories (right scale) 200

3200 (left scale) levels seen in the previous year (Figure 1.19,
160 bottom panel).
2000 Food Prices
1600 80
1200 Food prices fell by 34 percent in the second
800 40 half of 2008—led by corn, soybeans, and edible
2002 03 04 05 06 07 Mar.
09 oils (Figure 1.20, top panel). As for other non-
fuel commodities, the price declines reflected
Sources: Bloomberg Financial Markets; World Bureau of Metal Statistics; and IMF staff
calculations. not only slowing demand but also reduced
1 Spread between end-year futures contract and latest available spot price (January 30,
2009) in percent.
energy costs. In addition, improved supply
2 Inventories refer to the sum of global stocks of copper, aluminum, tin, zinc, nickel, and conditions for major grains and oil seeds were
lead monitored by the London Metal Exchange. Price refers to a composite index of those
metals. a key factor (Figure 1.20, second panel). The
latter reflected both increased acreage and
enhanced yield per acre in response to the ear-


lier high prices (Figure 1.20, third panel). Yield

per acre was boosted by greater use of higher-
quality seeds and fertilizers and more favorable
weather conditions, particularly in major wheat Figure 1.20. Recent Developments in Markets for Major
producers such as Russia and Ukraine. Food Crops1
There are concerns that declining prices
and the financial turmoil adversely affected Selected Food Prices 320
(index, January 2006 = 100)
supply-side prospects in the second half of 280
2008. In the face of weaker demand from Wheat 240
Futures curves as of
emerging economies, reduced biofuel produc- April 14, 2009
tion with declining gasoline demand, falling
energy prices, and insufficient financing amid
tightened credit conditions, farmers across the Soybeans
globe have reportedly reduced acreage and 2006 07 08 09 10
fertilizer use (Figure 1.20, bottom panel). For
example, the U.S. Department of Agriculture 225 Major Food Crops Production 2400
(right axis in millions of metric tons) (right scale)
projects that the combined area planted for the 200
Inventory cover 2100
country’s eight major crops will decline by 2.8 175 Price index (days of global consumption)
150 (2005 = 100) 1800
percent (year over year) during the 2009–10 Consumption
125 (right scale) 1500
crop year. At the same time, stocks of key food
staples, including wheat, are still at relatively 1200
low levels. These supply factors should partly 50 900
1989 91 93 95 97 99 2001 03 05 07 09
offset downward pressure from weak demand
during the downturn.
Production of Major Crops 2 15
(annual percent change) Production
Yield per acreage 12
Appendix 1.2. Fan Chart for Global Acreage 9
Growth 6

The author of this appendix is Prakash Kannan, 3

with research assistance provided by Murad Omoev. 0

Since the April 2006 issue of the World Eco- -6
1989 91 93 95 97 99 2001 03 05 07 09
nomic Outlook, global growth projections have
been accompanied by a fan chart, which illus-
20 Demand for Major Food Crops 48
trates the confidence intervals associated with (annual percent change)
Emerging and
end-year and next-year baseline projections. 15 Corn used for U.S. 36
ethanol production
The fan chart serves primarily as a visual com- economies
10 (right scale) 24
munication device that addresses the following
5 12
three questions:
• What is the baseline forecast for the current 0 0
and future years? Industrial countries3
-5 -12
• What level of uncertainty surrounds the 1995–2000 01 02 03 04 05 06 07 08 09
Sources: Bloomberg Financial Markets; U.S. Department of Agriculture; and IMF staff
• Where does the balance of risks lie? estimates.
1Major food crops are wheat, corn, rice, and soybeans.
The baseline WEO projection, however, is 2 Yield per acreage includes corn, rice, and wheat.
not based on a single formal model, but rather 3
Excludes corn used in U.S. ethanol production.
on a suite of models, together with informed
judgments made by IMF desk economists. As


such, the projections do not naturally have ing the underlying distribution of global
conventional measures of confidence intervals growth and the set of risk factors that are of
associated with them. In order to impose a the most immediate interest. As in the previous
greater degree of objectivity on the construc- version of the fan chart, a convenient assump-
tion of the fan chart, the existing methodology tion is that both global growth and the key
was modified to allow the incorporation of risk factors are drawn from a two-piece normal
information embedded in market indicators distribution function.17 The two-piece normal
that have strong associations with the level of distribution is widely used by central banks in
global economic activity. This information is the construction of fan charts because it has
subsequently aggregated and mapped into the the benefit of a simple-to-compute density func-
degree of uncertainty and the balance of risks tion and an ability to incorporate asymmetries
associated with global growth. This appendix (see, for example, Britton, Fisher, and Whitley,
provides a brief overview of the new method- 1998). Asymmetry in the distribution provides
ology, as well as an assessment of the current the source of the balance of risks illustrated in
reading of market indicators on the risks asso- the fan chart.
ciated with the global growth forecast.15 Three sets of macroeconomic variables are
The sources of information that were used considered to represent key quantifiable risk
to gauge the market’s assessment of risks range factors associated with global growth prospects.
from survey-based measures, such as those Survey or options price data for these variables
provided by Consensus Economics, to market- are used to construct one-year-ahead probabil-
based measures, such as option prices for equi- ity distributions for these variables. The vari-
ties and commodities. Consensus Economics ance and skew of these distributions, together
surveys more than 25 institutions each month with the relationship between these variables
for its forecasts regarding key macroeconomic and global real GDP growth, are then used to
indicators for a broad set of countries. The build the confidence intervals around WEO
variance and skew of the distribution of fore- projections for global real GDP growth. The
casts serve as proxies for the degree of uncer- three sets of variables cover (1) financial condi-
tainty as well as the balance of risk. Beyond the tions, (2) oil price risk, and (3) inflation risk.
fact that such data are easily obtained, the use Financial conditions are proxied by the term
of survey-based measures has the additional spread (measured as the long-term minus the
benefit of providing quantitative measures of short-term interest rate) and the returns of the
the distribution of risks related to macroeco- Standard & Poor’s (S&P) 500 index. Financial
nomic variables that do not have active markets market data are naturally forward looking, and
directly associated with them. Apart from the so they can convey useful information regard-
use of survey-based data, information embed- ing growth prospects. Increased asset price
ded in option prices for equities and commodi- volatility, for example, is a sign of heightened
ties has also been incorporated into the new uncertainty and will likely be associated with
methodology.16 less favorable growth developments. The slope
In order to construct uncertainty bands of the yield curve has been a reliable predictor
around the baseline forecasts for global of recessions because it embeds expectations
growth, assumptions need to be made regard- of future monetary policy and inflation, which
in turn are informative about future growth
15See Elekdag and Kannan (2009) for a more detailed

16Bahra (1997) is a good survey that covers the theo- 17The two-piece normal distribution is formed by com-

retical basis for a variety of methodologies used to extract bining two halves of two normal distributions that have
probability distributions from data on option prices along different variances but share the same mean. See John
with some useful applications. (1982) for a summary of its main properties.


prospects (see Estrella and Mishkin, 1996). As two-year horizons as a measure of the baseline
a result, the risk of a decrease in the slope of degree of uncertainty to construct the two-
the term spread is indicative of downside risk. piece normal distribution. In principle, this
Meanwhile, the oil price risk factor captures baseline measure of uncertainty could subse-
the risks associated with the baseline projec- quently be increased or decreased based on
tion for oil prices, which serves as a key input the level of the standard deviation of the risk
to individual country growth projections. factors relative to their historical levels. An
Finally, inflation risk is characterized by high alternative way of incorporating changes in the
or volatile price dynamics, which may trigger degree of uncertainty relative to the historical
aggressive monetary tightening, thereby poten- forecast error, and one that is applied in the
tially depressing growth. present approach, is through an aggregation
Information on the distribution of the three of the dispersion of real GDP forecasts for
sets of macroeconomic variables is subsequently individual countries. By comparing the disper-
mapped into real GDP growth on the basis sion of these individual growth forecasts with
of econometric relationships. The estimated their historical values, it is possible to obtain
elasticity of global growth with respect to stan- an indicator of the uncertainty associated
dardized estimates of the term spread, S&P 500 with global growth. Several studies, including
returns, inflation, and oil prices are 0.35, 0.15, Kannan and Kohler-Geib (2009) and Prati
–0.4, and –0.35, respectively. and Sbracia (2002), find that the dispersion of
The inflation forecasts compiled by Consen- growth forecasts is a significant predictor of
sus Economics for the United States, the euro financial crises.
area, Japan, and several key emerging markets The current distribution of forecasts for
were used to provide information for infla- GDP growth in key economies, as well as for
tion risk. The calculations for the term spread the identified risk factors, shows much higher
and oil price risk factors are performed in an dispersion relative to recent years, indicating
analogous manner. In the case of the term a larger degree of uncertainty associated with
spread, however, only data on the slope of the the baseline projection than has historically
yield curves in the United States, the United been the case (Figure 1.21). In the construc-
Kingdom, Japan, and Germany are used.18 tion of the fan chart (Figure 1.10), the increase
Finally, the balance of risks associated with in the dispersion of growth forecasts, relative
the equity market risk factor are obtained by to the average over the past 10 years, is trans-
estimating the distribution function of equity lated into a higher variance in the distribution
returns implicit in call option data on the S&P of global growth projections by augmenting
500 index.19 the historical one- and two-year-ahead forecast
Previous fan charts presented in the World errors proportionately. In this particular case,
Economic Outlook used historical forecast errors the standard deviation of the distribution was
for projections of global growth at the one- and increased by about 80 percent relative to its
historical average.
18The distribution of oil price forecasts was obtained Market indicators can also be used to provide
from Bloomberg Financial Markets, extracting informa- information on the balance of risks surround-
tion on the probability density function from option ing the baseline forecast. The measure of skew-
prices for oil-yield densities with peculiar shapes. How-
ness provides an indicator of the direction and
ever, recent IMF staff efforts that impose more restric-
tions on the shape of the density have yielded promising degree of imbalance in the distribution of sur-
results and will be used as an alternative measure in the vey forecasts or in the distribution of expected
future. future price changes implicit in option prices.
19The nonparametric constrained estimator introduced

in Ait-Sahalia and Duarte (2003) was used to estimate the The most recent reading of indicators on the
risk-neutral density of the S&P 500 returns. balance of risks arising from financial condi-


tions, equity markets, inflation, and oil prices

cumulatively points toward a downside risk to
Figure 1.21. Dispersion of Forecasts for GDP and global growth (Figure 1.22). The negative skew
Selected Risk Factors1 in the forecasts for the slope of the yield curve
and the negative skew implicit in the option
GDP 0.35 prices for the S&P 500 indicate continued stress
0.30 in financial market conditions. The negative
skew in the distribution of inflation forecasts
reflects in part limited room for further mon-
etary easing. Meanwhile, market indicators of
0.15 the risks associated with oil price shocks over
0.10 the next year appear to be roughly balanced,
0.05 with a slightly positive skew.
The incorporation of market indicators into
2000 01 02 03 04 05 06 07 08 Feb: the construction of the fan chart represents a
move toward using an objective analysis as a start-
20 Oil Inflation 0.35 ing point to gauge the balance of risk and the
18 level of uncertainty inherent in the baseline pro-
16 0.30 jection of global growth. From this starting point,
however, a layer of judgment can subsequently be
12 0.25
introduced in order to incorporate other impor-
8 0.20 tant risk factors. Indeed, as is explicitly shown
6 in Figure 1.22, an additional judgment factor is
4 0.15 introduced that relates to the overall balance of
risk associated with the projections for global
0 0.10
2000 02 04 06 08 Feb: 2000 02 04 06 08 Feb: growth for this year and the next. This additional
09 09
judgment factor is meant to capture some of the
0.35 Term Spread Equity Risk (VIX) 80 risks highlighted in the main text that do not
70 lend themselves to easy quantification.

0.25 50 Appendix 1.3. Assumptions behind the

40 Downside Scenario
0.20 30
The author of this appendix is Dirk Muir.
0.15 The downside scenario presented in the chap-
ter was developed using a global macroeconomic
0.10 0
2000 02 04 06 08 Feb: 2000 02 04 06 08 Feb: model, the National Institute Global Econo-
09 09
metric Model (NIGEM), based on a variety of
Sources: Consensus Economics; Bloomberg Financial Markets; Chicago Board Options
assumptions. A key component of the scenario is
Exchange; and IMF staff calculations. the spillovers from one region to another. These
1 The series for GDP and inflation measure the dispersion (standard deviation) of
GDP and inflation forecasts respectively for the G-7 economies, Brazil, India, China are based on the bilateral trade flows outlined in
and Mexico, taking into account the covariance of forecasts. The series for term
spread measures the dispersion of forecasts of the term spread (10-year Table 1.4.
government bond yield minus 3-month interest rate) for the United States, the United Using information in this table, the model
Kingdom, Germany and Japan. The oil price series measures the dispersion of
one-year ahead oil forecasts. Finally, the series for equity risk is the VIX series which decomposes the additional decline in output
measures the implied volatility of the S&P 500.
growth that occurs in this scenario, relative to
the WEO baseline, between the international
spillovers and the effects of domestic shocks in


Table 1.4. Underlying World Merchandise Trade Flows

(As a percent of world GDP)
Euro Emerging Latin Emerging Rest of Total
Importer United States Japan area Asia America Europe the world Imports
United States — 0.27 0.50 1.04 0.57 0.04 1.26 3.68
Japan 0.11 — 0.09 0.44 0.04 0.01 0.43 1.14
Euro area 0.33 0.14 — 0.76 0.18 0.59 1.74 3.74
Emerging Asia 0.41 0.61 0.43 — 0.15 0.05 1.36 3.15
Latin America 0.42 0.06 0.15 0.18 — 0.01 0.16 1.07
Emerging Europe 0.03 0.03 0.74 0.16 0.01 — 0.41 1.40
Rest of the world 0.82 0.20 1.88 1.02 0.17 0.34 — 4.38
Total exports 2.12 1.31 3.78 3.36 1.06 1.04 4.66 —
Source: IMF, Direction of Trade Statistics.

each region (Table 1.5). Three types of domestic relative to the baseline. Second, the price of oil
shock are considered: (1) additional financial declines by an additional 15 percent in 2009,
stress adding to credit constraints; (2) deeper ending 20 percent lower than the baseline by
corrections in housing markets, weighing on the end of 2010.
residential investment and private consumption;
and (3) large equity price declines, implying Table 1.5. Factors Explaining the Additional
weaker private consumption. Each of these Decline in Output Growth for 2009–10
shocks is applied in each region at one of three
United States Euro Area
intensities: mild, moderate, or severe, relative to
Additional decline * Additional decline *
the WEO baseline. International International
Consider the case of the United States. spillovers 63% spillovers 48%
Domestic factors: Domestic factors:
International spillovers in this case account for Financial ** Financial **
63 percent of further decline in GDP over 2009 Housing ** Housing **
Equity markets * Equity markets *
and 2010. The remaining 37 percent is attrib-
Japan Emerging Asia
uted to shocks related to domestic demand.
Additional decline * Additional decline **
There are additional moderate shocks to the International International
financial and housing sectors and an additional spillovers 61% spillovers 78%
mild shock in equity markets. Taken together Domestic factors: Domestic factors:
Financial ** Financial *
with the international spillovers, the United Housing * Housing *
States’ additional decline is relatively mild. Equity markets * Equity markets **
To summarize, mild declines, in comparison Latin America Emerging Europe
with the WEO baseline, are the case for the Additional decline ** Additional decline ***
United States, the euro area, and Japan. Emerg- International International
spillovers 40% spillovers 41%
ing Asia and Latin America face moderate Domestic factors: Domestic factors:
declines, with international spillovers dominat- Financial ** Financial ***
Housing * Housing ***
ing in emerging Asia. Emerging Europe suffers a Equity markets ** Equity markets *
severe additional decline, driven by large shocks Sources: IMF staff calculations; and National Institute Global
to the financial sector and the housing market, Econometric Model simulations.
“Additional decline” is a weighted average of international
with only a mild contribution from the equity
spillovers and domestic demand shocks.
market. “International spillovers” is the percentage of decline attributable
Finally, there are two global shocks. First, to the effects of international trade linkages.
***is a severe shock, relative to the WEO baseline.
trade volumes decline worldwide on average **is a moderate shock, relative to the WEO baseline.
in 2009 and 2010, by 10 percent to 15 percent, *is a mild shock, relative to the WEO baseline.


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This chapter discusses how the global crisis is affect- These shocks have depressed consumption; the
ing the various regions of the global economy. The household saving rate, which had been falling
United States is at the epicenter of the crisis, and is in for two decades, has risen sharply, to more than
the midst of a severe recession that has resulted from 4 percent in February 2009, up from about
a squeeze on credit, sharp falls in housing and equity ¼ percent a year earlier (Figure 2.1).
prices, and high uncertainty. These three shocks are Progress toward normalization of financial
to varying degrees also affecting the rest of the world. conditions has been much slower than envis-
Asia had little exposure to U.S. mortgage-related assets aged a few months ago. Financial markets
but is being badly affected by the slump in global have stabilized somewhat since the failure of
trade, given its heavy dependence on manufactur- Lehman Brothers and the rescue of American
ing exports. In Europe, as in the United States, the International Group (AIG) in September, but
financial system has been dealt a heavy blow, housing they remain under heavy stress, despite unprec-
corrections are intensifying, and industrial production edented government actions. Interbank markets
is being hit by the sharp drop in durables demand. are still unsettled, and spreads remain far above
Because of their heavy reliance on capital inflows to normal levels. Despite some relief in recent
sustain income growth in order to catch up to Western weeks, equity markets are still down more than
levels, both the emerging European and Common- 40 percent from their peaks, as economic pros-
wealth of Independent States (CIS) economies are pects have darkened and financial stocks have
suffering heavily, with the slump in commodity prices been hammered by heavy losses and questions
adding to the pain in many CIS economies. In Latin about solvency. The dollar has strengthened
America and the Caribbean, the fallout from the crisis significantly, reflecting flight to safety in govern-
is moving through both trade and financial chan- ment bonds as other economies have become
nels, intensified by the drop in commodity prices. The more deeply embroiled in the crisis.
Middle Eastern economies are suffering mainly because Real GDP contracted by 6.3 percent in the
of the decline in energy prices, and hard-won gains fourth quarter of 2008, and recent data suggest
in African economies are threatened by slumping com- another substantial drop in the first quarter of
modity prices and potentially lower aid inflows. 2009. There have been some tentative signs of
improving business sentiment and firming con-
sumer demand, but employment has continued
The United States Is Grappling with the to fall rapidly—5.1 million jobs have been lost
Financial Core of the Crisis since December 2007—pushing the unemploy-
The biggest financial crisis since the Great ment rate to 8.5 percent in March. Monetary
Depression has pushed the United States into policy was eased quickly in response to deterio-
a severe recession. Despite large cuts in policy rating economic conditions, and policy rates are
interest rates, credit is exceptionally costly or now close to zero. But credit market disruptions
hard to get for many households and firms, are undermining the effectiveness of rate cuts.
reflecting severe strains in financial institutions. The scope for further conventional monetary
In addition, households are being hit by large policy action is effectively exhausted, so the
financial and housing wealth losses (Box 2.1), Federal Reserve has moved aggressively since
much lower earnings prospects, and elevated the fall to use alternative channels to ease credit
uncertainty about job security, all of which have conditions and has been prepared not only to
driven consumer confidence to record lows. alter the composition of its balance sheet but


to expand its size dramatically as well. A broad

Figure 2.1. United States: The Center of the Crisis array of new facilities has been introduced to
Falling wealth, tight credit markets, and heightened uncertainty about job security and ensure that credit flows throughout the finan-
earnings are reining in private demand. Declining output and employment are causing
declines in loan repayments. The damage to bank balance sheets is tightening access cial system, including to revive the markets for
to credit, feeding back into private investment and consumption. securities backed by a broad array of consumer
credit assets.1 In mid-March, the Federal Reserve
10 Consumption and Wealth 8 175 Housing Market 8 announced plans to purchase long-term U.S.
Real consumption Case-Shiller 2
8 growth 6 Treasury securities and increase its purchases of
Household 150
6 (left scale) 7 4
net worth
agency-backed mortgage-backed securities and
(right scale) 2
125 agency debentures.
2 6 The economy is now projected to contract
0 100 2 by 2.8 percent in 2009, even though the rate of
Saving rate decline is expected to moderate in the second
-2 5 -6
(left scale) 75 Change in residential
-4 investment 3 -8 quarter and beyond as fiscal easing supports
(right scale)
-6 4 50 -10 consumer demand and the rate of inventory
2002 04 06 08: 2002 04 06 08:
Q4 Q4 adjustment eases (Table 2.1). Contingent on
900 Labor Market 9 Credit Card Delinquencies5 6 fiscal stimulus (equivalent to about 5 percent
450 8 of GDP) over 2009–11, a continued easy mon-
0 7 etary policy stance, measures to stabilize house
prices and stem the tide of foreclosures, and
-450 6
new policy measures to heal the financial sector
-900 5
(see below), the economy is projected to start
Unemployment rate 2
-1350 4 recovering by the middle of 2010. Average GDP
(right scale)
-1800 Change in employment 3 growth in 2010 is projected to be zero percent
(left scale)
-2250 2 0 (on a fourth-quarter-to-fourth-quarter basis,
2002 04 06 09: 2002 04 06 Mar.
Q1 09 growth is projected to reach 1.5 percent). There
120 Credit Tightness6 Loan Spreads and Demand6 100 are upside risks to the forecast, as financial
CIL CNC 80 conditions could recover faster than projected.
90 CNM CNMS SLR 60 However, there are notable downside risks
40 related to the potential for further intensifica-
20 tion of the negative interaction between the real
0 and financial sides of the economy: the housing
-20 sector could continue to deteriorate, further
0 -40 declines in asset values could increase insolvency
problems for banks and further reduce credit
-30 -80
2002 04 06 09: 2002 04 06 09: availability, deflation could raise real debt bur-
Q1 Q1
dens, and demand from other economies could
Sources: Haver Analytics; Fitch Ratings; Federal Reserve Board of Governors; and IMF
staff estimates. fall more than anticipated.
1Real consumption growth and saving rate are in percent; household net worth is ratio to
disposable income.
Prospects depend critically on policy initia-
2Index: 2002:Q1 = 100. National Association of Realtors (NAR); three-month moving tives to mitigate the severity of the recession and
average of 12-month percent change; Federal Housing Finance Agency (FHFA).
3 Quarterly change in percent. spur recovery. The most pressing policy issue
4Quarterly change in total nonfarm payrolls, thousands.
5 Fitch’s Prime Credit Card Delinquency Index.
6 All series come from Senior Loan Officer Survey. CIL: banks tightening C&I loans to 1The Federal Reserve has created the Term Asset-
large firms; CNC: banks tightening standards for consumer credit cards; CNM: banks
tightening standards for mortgages to individuals; CNMS: banks tightening standards for Backed Securities Loan Facility (TALF), which allows it
subprime mortgages to individuals; CNMP: banks tightening standards for prime to lend on a nonrecourse basis to investors in securities
mortgages to individuals; SSD: net percentage of domestic respondents reporting stronger backed by a variety of consumer loans (for example, auto
demand for C&I loans for small firms; SLR: net percentage of domestic respondents
loans and student loans), thus effectively providing both
increasing spreads of loan rates over banks’ cost of funds for small firms.
liquidity and protection against loan losses.


Table 2.1. Advanced Economies: Real GDP, Consumer Prices, and Unemployment1
(Annual percent change and percent of labor force)
Real GDP Consumer Prices Unemployment
2007 2008 2009 2010 2007 2008 2009 2010 2007 2008 2009 2010
Advanced economies 2.7 0.9 –3.8 0.0 2.2 3.4 –0.2 0.3 5.4 5.8 8.1 9.2
United States 2.0 1.1 –2.8 0.0 2.9 3.8 –0.9 –0.1 4.6 5.8 8.9 10.1
Euro area2 2.7 0.9 –4.2 –0.4 2.1 3.3 0.4 0.6 7.5 7.6 10.1 11.5
Germany 2.5 1.3 –5.6 –1.0 2.3 2.8 0.1 –0.4 8.4 7.3 9.0 10.8
France 2.1 0.7 –3.0 0.4 1.6 3.2 0.5 1.0 8.3 7.8 9.6 10.3
Italy 1.6 –1.0 –4.4 –0.4 2.0 3.5 0.7 0.6 6.1 6.8 8.9 10.5
Spain 3.7 1.2 –3.0 –0.7 2.8 4.1 0.0 0.9 8.3 11.3 17.7 19.3
Netherlands 3.5 2.0 –4.8 –0.7 1.6 2.2 0.3 1.1 3.2 2.8 4.1 5.0
Belgium 2.6 1.1 –3.8 0.3 1.8 4.5 0.5 1.0 7.5 6.8 9.5 10.5
Greece 4.0 2.9 –0.2 –0.6 3.0 4.2 1.6 2.1 8.3 7.6 9.0 10.5
Austria 3.1 1.8 –3.0 0.2 2.2 3.2 0.5 1.3 4.4 3.8 5.4 6.2
Portugal 1.9 0.0 –4.1 –0.5 2.4 2.6 0.3 1.0 8.0 7.8 9.6 11.0
Finland 4.2 0.9 –5.2 –1.2 1.6 3.9 1.0 1.1 6.8 6.4 8.5 9.3
Ireland 6.0 –2.3 –8.0 –3.0 2.9 3.1 –0.6 1.0 4.5 6.1 12.0 13.0
Slovak Republic 10.4 6.4 –2.1 1.9 1.9 3.9 1.7 2.3 11.0 9.6 11.5 11.7
Slovenia 6.8 3.5 –2.7 1.4 3.6 5.7 0.5 1.5 4.9 4.5 6.2 6.1
Luxembourg 5.2 0.7 –4.8 –0.2 2.3 3.4 0.2 1.8 4.4 4.4 6.8 6.0
Cyprus 4.4 3.7 0.3 2.1 2.2 4.4 0.9 2.4 3.9 3.7 4.6 4.3
Malta 3.6 1.6 –1.5 1.1 0.7 4.7 1.8 1.7 6.4 5.8 6.9 7.6
Japan 2.4 –0.6 –6.2 0.5 0.0 1.4 –1.0 –0.6 3.8 4.0 4.6 5.6
United Kingdom2 3.0 0.7 –4.1 –0.4 2.3 3.6 1.5 0.8 5.4 5.5 7.4 9.2
Canada 2.7 0.5 –2.5 1.2 2.1 2.4 0.0 0.5 6.0 6.2 8.4 8.8
Korea 5.1 2.2 –4.0 1.5 2.5 4.7 1.7 3.0 3.3 3.2 3.8 3.6
Australia 4.0 2.1 –1.4 0.6 2.3 4.4 1.6 1.3 4.4 4.3 6.8 7.8
Taiwan Province of China 5.7 0.1 –7.5 0.0 1.8 3.5 –2.0 1.0 3.9 4.1 6.3 6.1
Sweden 2.6 –0.2 –4.3 0.2 1.7 3.3 –0.2 0.0 6.1 6.2 8.4 9.6
Switzerland 3.3 1.6 –3.0 –0.3 0.7 2.4 –0.6 –0.3 2.5 2.7 3.9 4.6
Hong Kong SAR 6.4 2.5 –4.5 0.5 2.0 4.3 1.0 1.0 4.0 3.5 6.3 7.5
Czech Republic 6.0 3.2 –3.5 0.1 2.9 6.3 1.0 1.6 5.3 4.2 5.5 5.7
Norway 3.1 2.0 –1.7 0.3 0.7 3.8 1.5 1.9 2.5 2.6 3.7 4.7
Singapore 7.8 1.1 –10.0 –0.1 2.1 6.5 0.0 1.1 2.1 3.1 7.5 8.6
Denmark 1.6 –1.1 –4.0 0.4 1.7 3.4 –0.3 0.0 2.7 1.7 3.2 4.5
Israel 5.4 3.9 –1.7 0.3 0.5 4.7 1.4 0.8 7.3 6.0 7.5 7.7
New Zealand 3.2 0.3 –2.0 0.5 2.4 4.0 1.3 1.1 3.6 4.1 6.5 7.5
Iceland 5.5 0.3 –10.6 –0.2 5.0 12.4 10.6 2.4 1.0 1.7 9.7 9.3
Major advanced
economies 2.2 0.6 –3.8 0.0 2.1 3.2 –0.4 0.0 5.4 5.9 8.0 9.3
Newly industrialized
Asian economies 5.7 1.5 –5.6 0.8 2.2 4.5 0.4 2.0 3.4 3.5 4.9 4.9
1When countries are not listed alphabetically, they are ordered on the basis of economic size.
2Based on Eurostat’s harmonized index of consumer prices.

is to restore the health of the core financial since the scope for monetary policy has become
institutions. At the same time, it is important limited on multiple fronts.
to stimulate private demand (not just for the Crucially, policies must address the problems
direct effects but also to break the cycle of fall- at the core of the financial system: the grow-
ing asset prices, rising losses in financial institu- ing burden of problem assets and uncertainty
tions, and tighter credit); lower the risk of asset about banks’ solvency. Balance sheets need to
price overshooting on the downside, especially be restored, both by removing bad assets and by
for house prices; and reduce uncertainty facing injecting new capital in a transparent manner,
households, firms, and financial markets. In this so as to convince markets of these institutions’
regard, the main burden will fall on fiscal policy return to solvency. The strategy for banks has


Box 2.1. The Case of Vanishing Household Wealth

The financial crisis has erased household of disposable income) increased by more
wealth in many advanced economies. The than 100 percentage points in the United
precipitous fall in asset prices—across equity, States, euro area, and United Kingdom. On
bond, and housing markets—has eroded the the liability side, gross financial obligations
value of financial and housing assets and the increased in these three economies by about
net worth of households.1 For instance, during 20–40 percentage points and remained
the first three quarters of 2008 alone, the value broadly unchanged in Japan.
of household financial assets decreased by
about 8 percent in the United States and the
United Kingdom, by close to 6 percent in the
euro area, and by 5 percent in Japan. As global Household Assets, Liabilities, and Net Worth1
equity markets plunged in the last quarter of (In percent of gross disposable income)
2008, household financial wealth declined
further—for example, by an additional 10 per- Financial assets Financial liabilities
Housing assets Net worth
cent in the United States. At the same time,
the value of housing assets also deteriorated in
line with falling house prices, especially in the 1200 United States United Kingdom 1200

United States and the United Kingdom. 1000 1000

The sharp deterioration in household wealth 800 800

prompts a number of questions: How vulner- 600 600
able were household balance sheets across 400 400
countries before the crisis? What are the main 200 200
channels through which balance sheet develop- 0 0
ments could affect real activity? What are the -200 -200
1999 2002 05 08 1999 2002 05 08
likely effects on the economy this time around?
The purpose of this box is to address the above
1200 Japan Euro Area 1200
questions using available data and evidence on
the topic. 1000 1000
800 800
What Was the Starting Position? 600 600
In advanced economies, households faced 400 400
the financial crisis with higher net worth but 200 200
also with more vulnerable, leveraged balance 0 0
sheets. -200 -200
1999 2002 05 08 1999 2002 05 08:
• Household net worth rose substantially in Q3
the four largest advanced economies during Sources: Bank of Japan, Cabinet Office (Japan), European Central
2002–06 (first figure).2 On the asset side, Bank, Eurostat, Office of National Statistics, Haver Analytics, and
IMF staff estimates.
in tandem with asset prices, gross finan- 1Data cover households and non-profit organizations in the
cial and housing wealth (as a percentage United States, and households and non-profit institutions serving
households in the Euro area, the United Kingdom, and Japan. The
housing wealth data refer to the value of residential buildings in the
The main author of this box is Petya Koeva Brooks. United States; the value of real estate holdings in the United
1Net worth is defined as total assets (housing and Kingdom; housing wealth at current replacement value in the Euro
area; and tangible non-produced assets (excluding fisheries) of
financial) minus financial liabilities. households and private unincorporated enterprises in Japan. The
2As a percentage of disposable income, net worth housing wealth data are estimated for 2007 and 2008 in Japan and
increased during 2002–06 by 114 percentage points for 2008 in the Euro area and the United Kingdom, based on
observed changes in house prices. Data for United States, the
in the United States, 90 percentage points in the euro United Kingdom, and Japan are up to 2008:Q4; data for the Euro
area, 125 percentage points in the United Kingdom, area are up to 2008:Q3.
and 23 percentage points in Japan during 2002–06.


• The increased size of household assets,

Household Leverage Ratios1
coupled with their composition, implied
higher overall vulnerability to equity and
United States Euro area
house price shocks, with notable differences
Japan United Kingdom
across countries. The broad composition of
assets reveals that gross household wealth
Leverage 1: Financial Leverage 2: Financial
is more dependent on housing assets in 240 Liabilities 100
the United Kingdom and euro area and on (in percent of gross (in percent of net
200 disposable income) household financial
financial assets in the United States and 80
Japan (see first figure). As far as the compo- 160
sition of financial assets is concerned, most 120
notable is the large share of deposits held by
Japanese households. Taken together, these 80
observations suggest that in relative terms, 40 20
1999 2002 05 08 1999 2002 05 08
U.S. households were more vulnerable to
equity price shocks and U.K. and euro area
Leverage 3: Financial Leverage 4: Financial
households to house price shocks. 40 Liabilities Liabilities 300
• Household balance sheets generally became (in percent of (in percent of
household net worth) household deposits) 250
more leveraged (second figure). In the
30 200
advanced economies other than Japan,
financial liabilities rose—as a percentage 150
of disposable income, net financial assets, 20 100
net worth, and household deposits. But
the leverage ratios also indicate substantial
10 0
differences across countries. For instance, 1999 2002 05 08 1999 2002 05 08
although household financial liabilities
relative to net worth remained broadly Sources: Bank of Japan, Cabinet Office (Japan), European Central
Bank, Eurostat, Office of National Statistics, Haver Analytics, and
unchanged in Japan and rose moderately in IMF staff estimates.
1For the Euro area, data refer to 2008:Q3.
the euro area, they increased substantially in
the United Kingdom and the United States—
from about 17 percent of net worth in 1999 future (in terms of shelter) are unchanged.
to more than 28 percent at end-2008. Therefore, one could think about the fall
in price as a mere change in relative prices
How Do Household Balance Sheets Affect Economic (between houses/housing services and all
Activity? other goods and services) that makes those
In theory, there are several possible channels long in housing poorer but those short in
of transmission. housing richer, with no obvious aggregate
• The most traditional channel is through wealth effect.3 This argument does not hold,
wealth effects. In response to an unexpected however, if there is a bubble in the hous-
loss in net worth, consumers are likely to cut ing market, if the marginal propensity to
their current spending by a fraction of the consume differs between the two groups, or
change in wealth and maintain the new level if housing wealth can be collateralized (see
of spending over time. The existence of a below).4
housing wealth effect is somewhat controver-
sial, however. Some have argued that even
if house prices fall, the houses are all still 3For example, King (1998) and Buiter (2008).
there, and the services they provide for the 4See Buiter (2008).


Box 2.1 (concluded)

• Another possible channel is through credit/ Furthermore, there is no consensus on how

collateral effects. Households can borrow wealth effects differ between housing and
against the equity in their homes and use it financial wealth, although some studies find a
to finance consumption. If households face stronger housing wealth effect, despite theoreti-
liquidity constraints, a decrease in their net cal arguments to the contrary.7 Estimates of
worth could lead to higher costs for and housing wealth effects tend to be larger in the
reduced availability of borrowing, further United States and the United Kingdom than
lowering consumption. in the euro area and Japan.8 In policymaking,
• A third channel is through possible distri- the FRB/US model used by the Federal Reserve
butional effects. Because households may incorporates a 0.038 long-run marginal propen-
respond differently to shocks depending on sity to consume out of housing wealth, which
their debt levels, aggregate consumption is identical to that of financial wealth, whereas
could also be affected by the amount of debt the Bank of England’s model contains no such
outstanding and by its distribution. In addi- long-run effect.
tion, the composition of household assets
and their relative (il)liquidity may play a role What Are the Likely Effects of Household Balance
in determining how consumption responds Sheet Developments in the Current Circumstances?
to shocks. Although its exact contribution is hard to
Disentangling and assessing the empirical assess, the recent destruction of wealth is likely
importance of the various channels of trans- to contribute to a rise in the household saving
mission have been extremely hard, given the rate and weakness in consumption in advanced
difficulties in controlling for the effects of economies, especially in the United States and
income expectations and other unobserved the United Kingdom, where the decline in net
factors.5 Therefore, it may be more appropriate worth has been the largest so far. For instance,
to treat the estimates of wealth effects (mar- as shown in the table, the losses in household
ginal propensity to consume out of financial wealth during 2008 were about $11 trillion in
and housing assets) as capturing a more broad the United States ($8.5 trillion in financial
(reduced-form) relationship between wealth and assets and $2.5 trillion in housing assets) and
consumption, rather than a pure wealth effect. were estimated at £1 trillion in the United
These estimates generally vary between 0 and Kingdom (£0.4 trillion in financial assets and
0.10, depending on the type of asset (housing,
financial), data (micro, macro), financial system
(bank based, market based), country, and so
forth.6 chapter 3 in the April 2008 World Economic Outlook.
The magnitude in the Federal Reserve FRB/US
model is 0.0375.
5Quantifying the importance of the distributional 7See Ludwig and Sløk (2004); and Case, Quigley,

channel has been particularly challenging, although and Shiller (2005).

there is some evidence suggesting that responses to 8For the euro area, Slacalek (2006) finds that

shocks were stronger when indebtedness was higher the marginal propensity to consume out of housing
(Balke, 2000). Based on the experience of the United wealth is zero, although there appears to be substan-
Kingdom and the Scandinavian countries in the early tial variation across euro area countries, with positive
1990s, Debelle (2004) also argues that high household effects in Italy and France (Sierminska and Takhta-
indebtedness amplified the transmission of other manova, 2007; Grant and Peltonen, 2008; Paiella,
shocks. 2004; and Boone and Girouard, 2002). For the United
6For advanced economies, the marginal propen- States and the United Kingdom, the estimates tend
sity to consume out of financial wealth is typically to be larger (in the range of 0.03–0.10). See Bertaut
estimated in a range between 0.00 and 0.09—if wealth (2002); Carroll, Otsuka, and Slacalek (2006); Slacalek
rises by $1, spending rises by between zero and nine (2006); Skinner (1993); Lehnert (2004); Campbell
cents. For example, see Catte and others (2004) and and Cocco (2007); and Boone and Girouard (2002).


Illustrative Long-Run Effects of Wealth Destruction on Household Saving Rate

2007:Q4–2008:Q4 2008:Q4–2009:Q4 Long-Run Effect
United United United United United United
States Kingdom States Kingdom States Kingdom

(in percent)
Change in housing wealth1 –11 –16 –10 –10
Change in financial wealth1,2 –10 –9 –4 –3
(in percentage points)
Long-run effect on saving rate (low MPC = 0.02)3,4 2.6 3.2 0.7 1.2 3.3 4.5
Long-run effect on saving rate (high MPC = 0.07)4 8.9 11.2 2.5 4.1 11.5 15.6
Sources: U.K. Office for National Statistics; Haver Analytics; and IMF staff estimates.
1For the United Kingdom, housing wealth data are currently available until 2007:Q4. The assumed changes in housing wealth during

2007:Q4–2008:Q4 correspond to the average change in the Nationwide and Halifax price indices during the same period.
2The assumed changes in financial wealth during 2008:Q4–2009:Q4 are based on (1) the observed changes in equity markets

(Wilshire 5000 Index for the United States and FTSE All Share Index for the United Kingdom) between December 31, 2008, and
March 31, 2009, and (2) the assumption that the change in the value of nondeposit financial assets is one-half the change in equity
3The marginal propensity to consume out of wealth (MPC) is assumed to be the same for housing and financial assets.
4The impact on the saving rate is computed by multiplying the MPC and the shortfall in wealth (relative to a scenario in which wealth

grows in line with disposable income) and dividing by the initial level of disposable income. Nominal disposable income growth was
2.9 percent in the United States and 4.7 percent in the United Kingdom during 2007:Q4–2008:Q4 and is assumed to be 0 percent in the
United States and 1 percent in the United Kingdom during 2008:Q4–2009:Q4.

£0.6 trillion in housing assets).9 The long-run 3–4 percent during 2008:Q4–2009:Q4—which
impact on the saving rate of these losses could is consistent with the observed decline in equity
be in the range of 2½–9 percentage points markets during the first quarter of 2009—and
in the United States and 3¼–11¼ percentage that there are no further changes in financial
points in the United Kingdom, depending on wealth during the rest of 2009 and the value
the assumed marginal propensity to consume.10 of housing assets decreases by 10 percent. This
Equity and house prices have already could be associated with an additional increase
adjusted significantly, especially in the United in the household saving rate of about ¾–2½
States. But they may continue to decline and— percentage points in the United States and
given the increased vulnerability of household 1¼–4 percentage points in the United King-
balance sheets to asset price shocks—reduce dom over the coming years (see table). As a
household net worth and consumption further. result, over the long run, the cumulative effect
For example, let us suppose that the value of the declines in housing and financial wealth
of household financial wealth decreases by on the household saving rate could be in the
range of 3¼–11½ percentage points for the
9For the United Kingdom, housing wealth as of
United States and 4½–15½ percentage points
end-2008 is derived under the assumption that the
for the United Kingdom. In sum, household
value of housing assets declines in line with the savings in these countries are expected to rise
change in nominal house prices (see also footnote 1 and remain substantially higher than in the
of the table). past decade, even after the impact wanes of
10These estimates should be treated as illustrative
other factors that now constrain consumption
only, since their inputs are subject to a large degree of
uncertainty. Moreover, they do not capture the effects
(such as tighter restrictions on credit avail-
of all the other factors that are affecting private saving ability, concerns about unemployment, and
at the same time. precautionary saving).


two aspects, both designed to improve the should be a useful step in improving liquidity
quality of banks’ balance sheets and enable and transparency in the underlying markets, but
them to increase lending activity. First, banks its effectiveness in removing problem assets will
with more than $100 billion in assets face a depend crucially on the willingness of the banks
mandatory stress test to assess whether their that hold these assets to sell them at a price
existing levels of capital are robust to further consistent with the available resources under the
declines in asset prices and economic activ- program. The approach to recapitalization is
ity. Banks that cannot raise additional capital also not without potential problems. At present,
from private investors to fill identified capital evaluating the long-term viability of financial
shortfalls will receive additional government institutions is a daunting task: the assessment
funds. Second, the Public-Private Investment must take into account the prospects for their
Program (PPIP) was announced to clear bank future profitability and business model, as well
balance sheets of troubled assets. The multi- as the quality of capital and management. Once
pronged plan intends to leverage private capital a benchmark is established for the appropriate
within public-private partnerships to purchase level of regulatory capital that reflects the need
distressed assets, potentially allowing purchases for buffers to absorb future losses, the recapital-
of $500 billion to $1 trillion. Bank participa- ization of viable banks with insufficient capital
tion in the plan, however, is entirely voluntary, should proceed quickly, with public money if
as banks are not required to sell their assets. necessary. To improve confidence and funding
The underlying idea behind the plan is that if prospects, the capital infusion should be in the
financial institutions are purged of bad assets, form of common shares, even if the government
they will be more likely to attract new capital becomes a majority shareholder. At the same
from the private sector. Furthermore, creating a time, nonviable institutions would need to be
viable market in assets that are currently nearly intervened promptly, leading to orderly resolu-
impossible to price will reduce uncertainty over tion through closure or merger.
the solvency of financial institutions. Moreover, Much hinges on the ability of the strategy to
recognizing that further declines in the price of restore financial stability, both in terms of direct
mortgage-backed securities will also hurt banks, effects and in terms of underlying monetary and
the administration is applying $75 billion in fiscal policy measures. Although the political
public funds toward curbing foreclosures by economy of policy implementation is complicated
offering cash incentives for lenders to modify by the public’s doubts about the wisdom of bail-
loans, allowing borrowers with high loan-to- ing out financial players, there is a grave danger
value mortgages to refinance into new, govern- that further delays, piecemeal action, and uncer-
ment-backed mortgages with a lower interest tainty could mean worsening conditions in the
rate, and increasing the capacity of Fannie Mae real economy, increasing the large collateral dam-
and Freddie Mac to buy mortgages. age inflicted by the correction of past mistakes
The challenge for any public attempt to and thus the ultimate cost of bank resolution.
remove bad assets is to induce banks to sell Fiscal policy must play an important part in
them—shareholders will be unwilling to accept supporting demand in the presence of restric-
“fire-sale” prices—while not paying too high a tions on credit availability (see Chapter 3). Tax
price, which would amount to a taxpayer subsidy rebates helped boost consumption modestly in
to bank owners and bondholders and could mid-2008, but their effects have now dissipated.
quickly exhaust Troubled Asset Relief Program A much larger discretionary stimulus pack-
(TARP) funds.2 The recently announced PPIP age has now been passed into law, combining
further tax relief with federal assistance to states
2The new budget proposal sent to Congress would add and additional expenditures (mainly on social
$250 billion to these funds on a net basis. programs and infrastructure), which is expected


to provide a 2.0 percent of GDP stimulus in SAR, Korea, Singapore, Taiwan Province of
2009 and 1.8 percent in 2010. This spending, China) declined at rates between 10 percent
together with the expected losses from financial and 25 percent, and southeast Asian emerg-
system support operations, the impact of the ing economies have also been badly damaged.
cycle, and the fall in asset prices, is projected to These falls resulted mostly from the collapse
bring the federal budget deficit to about 10 per- in demand for consumer durable goods and
cent of GDP in 2010. Against this backdrop, it capital goods in (non-Asian) advanced econo-
will be important to develop strategies to reverse mies and, to a lesser degree, the deterioration
the buildup of debt over the medium run. The in global financial conditions. China and India
current proposed budget is transparent about have also been affected by contraction in the
this issue but is based on growth assumptions export sector, but their economies have contin-
that are more optimistic than contained in ued to grow because trade is a smaller share of
these projections. More may need to be done to the economy and policy measures have sup-
ensure long-term fiscal sustainability. Otherwise, ported domestic activity. Also, there were some
there is a risk of upward pressure on interest signs of a turnaround in economic activity in
rates that will slow a recovery of the private China in the first quarter of 2009. At the same
sector. time, inflation pressures are subsiding quickly
Although there is no further room for interest in most economies, owing to weaker growth and
rate cuts, the Federal Reserve should continue lower commodity prices.
its efforts to use its balance sheet to support The impact on the real economy through the
credit markets, mindful of the need for an trade channel has been severe and similar across
exit strategy. Some positions could be quickly Asia. The drop in global demand has been
unwound once conditions normalize, but it may particularly focused on automobiles, electronics,
be more difficult to divest long-term assets, and and other consumer durable goods that are an
thus there is a need to consider new instruments integral part of the production structure across
to absorb liquidity, for example, issuance of Fed- east Asia. As a result, exports and industrial pro-
eral Reserve paper. In addition, the authorities duction have plummeted (Figure 2.2).
must be clear about the goals of unconventional Spillovers from the global financial crisis to
policy measures. domestic financial markets across Asia have also
been substantial. Equity and bond prices have
plummeted, sovereign and corporate spreads
Asia Is Struggling to Rebalance Growth have increased, and interbank spreads have
from External to Domestic Sources risen. Real estate markets have remained under
The impact of the global crisis on economies pressure in a number of economies (Singapore,
in Asia has been surprisingly heavy. There were China). Currencies have depreciated in most of
many reasons to expect Asia to be relatively the region’s emerging economies, although the
shielded from the crisis: unlike Europe, the yen has appreciated considerably since Septem-
region was not heavily exposed to U.S. securi- ber 2008 (as carry trades have been unwound),
tized assets, and improved macroeconomic fun- and the renminbi has remained broadly
damentals and (with a few exceptions) relatively unchanged relative to the dollar. Portfolio and
sound bank and corporate balance sheets were other flows have dwindled, implying tighter
expected to provide buffers. Nevertheless, since domestic credit conditions. As a result, many
September 2008, the crisis has spread quickly to banks and firms have begun to experience seri-
Asia and has dramatically affected its economies. ous stress.
Japan’s economy contracted at a 12 percent Growth projections for Asia have been
(annualized) rate in the fourth quarter. The marked down to varying degrees, in line with
newly industrialized economies (Hong Kong weaker global demand and tight external finan-


Figure 2.2. Advanced and Emerging Asia: Suffering from cial conditions and despite countercyclical mac-
the Collapse of Global Trade1 roeconomic policies. Activity in advanced Asia is
expected to drop sharply, and some economies
Asia has been hit hard by the global crisis, mainly through the trade channel, as
production and exports have plummeted across the region. Advanced economies in
could even experience deflation. Emerging Asia
the region are among the most affected, due to their high export dependence and is expected to continue to grow, led by China
large exposure to the drop in global demand for automobiles, electronics, and other
consumer durable goods. Also constrained by lower capital inflows and tighter credit
and India (Table 2.2). A modest recovery is
conditions, real activity in emerging Asia is slowing sharply too, despite a projected in 2010, underpinned by a pickup in
considerable boost from monetary and fiscal policies.
global growth and a boost from expansionary
12 Real GDP Growth Industrial Production2 30 fiscal and monetary policies. Despite the col-
(percent) Emerging lapse in exports, the current account surplus for
10 Developing Asia 20
8 10 Asia is projected to remain broadly unchanged
6 World 0 at about 4¾ percent of GDP, with significant
World -10 improvements in the current account positions
2 Japan and -20 of Korea and Taiwan Province of China in 2009
0 NIEs
Japan and -30 (Table 2.3).
NIEs -40
-4 The exact channels of transmission of the
-6 -50
external shocks and the severity of their impact
-8 -60
1990 95 2000 05 10 2000 02 04 06 Feb. vary considerably across economies. The
advanced economies in the region are taking
60 Merchandise Exports2 Export Composition by Key 60 the hardest hit, given their greater exposure
Emerging Asia Sectors
40 (percent of total exports) to the decline in external demand in other
Telecommunications advanced economies, especially for automo-
20 Electrical machinery
Road vehicles 40 biles, electronics, and investment goods. For
the group as a whole, real GDP is projected
-20 World to contract by about 6 percent in 2009, after
-40 expanding by about 3½ percent before the crisis
Japan and
-60 NIEs in 2007. The Japanese economy is projected to
contract by 6¼ percent in 2009, since the yen’s
-80 0
2000 02 04 06 Feb. Japan China India
strength and tighter credit conditions more gen-
erally have added to the problems of the export
Policy Interest Rates
9 Current Account (percent) 16 sector; mild deflation is expected to persist at
(percent of GDP)
least through 2010. Given their extreme open-
12 ness and high dependence on external demand,
Japan and
NIEs ASEAN-4 the other advanced economies in the region–
3 8 –Hong Kong SAR, Korea, Singapore, Taiwan
China Province of China––will also suffer. Among these
0 4 economies, Singapore and Hong Kong SAR are
Emerging Asia
excluding NIEs Japan and particularly exposed, given their importance as
-3 0 global financial centers. Vulnerable corporate
1990 95 2000 05 10 2000 02 04 06 Mar.
09 and household balance sheets will exacerbate
the impact of external shocks in Korea.
Sources: Bloomberg Financial Markets; Dealogic; Haver Analytics; United Nations
Comtrade Database; and IMF staff estimates. Growth in China is expected to slow to about
1Newly industrialized Asian economies (NIEs) comprise Hong Kong SAR, Korea,
6½ percent in 2009, half the 13 percent growth
Singapore, and Taiwan Province of China. ASEAN-4 countries comprise Indonesia,
Malaysia, Philippines, and Thailand. ASEAN-5 countries comprise ASEAN-4 countries and rate recorded precrisis in 2007 but still a strong
Vietnam. Emerging Asia comprises China, India, Indonesia, Malaysia, Philippines, and
Thailand. performance given the global context. Two fac-
2Annualized percent change of three-month moving average over previous three-month
tors are helping sustain the momentum despite
3Excluding Taiwan Province of China. the collapse in exports. First, the export sector


Table 2.2. Selected Asian Economies: Real GDP, Consumer Prices, and Current Account Balance
(Annual percent change, unless noted otherwise)
Real GDP Consumer Prices1 Current Account Balance2
2007 2008 2009 2010 2007 2008 2009 2010 2007 2008 2009 2010
Emerging Asia3 9.8 6.8 3.3 5.3 4.9 7.0 2.5 2.4 6.6 5.5 6.3 5.8
China 13.0 9.0 6.5 7.5 4.8 5.9 0.1 0.7 11.0 10.0 10.3 9.3
South Asia4 8.7 7.0 4.3 5.3 6.9 9.0 7.7 4.5 –1.4 –3.4 –2.6 –2.7
India 9.3 7.3 4.5 5.6 6.4 8.3 6.3 4.0 –1.0 –2.8 –2.5 –2.6
Pakistan 6.0 6.0 2.5 3.5 7.8 12.0 20.0 6.0 –4.8 –8.4 –5.9 –4.9
Bangladesh 6.3 5.6 5.0 5.4 9.1 8.4 6.4 6.1 1.1 0.9 0.9 –0.1
ASEAN–5 6.3 4.9 0.0 2.3 4.3 9.2 3.6 4.5 4.9 2.8 2.2 1.5
Indonesia 6.3 6.1 2.5 3.5 6.0 9.8 6.1 5.9 2.4 0.1 –0.4 –0.7
Thailand 4.9 2.6 –3.0 1.0 2.2 5.5 0.5 3.4 5.7 –0.1 0.6 0.2
Philippines 7.2 4.6 0.0 1.0 2.8 9.3 3.4 4.5 4.9 2.5 2.3 1.6
Malaysia 6.3 4.6 –3.5 1.3 2.0 5.4 0.9 2.5 15.4 17.4 12.9 10.7
Vietnam 8.5 6.2 3.3 4.0 8.3 23.1 6.0 5.0 –9.8 –9.4 –4.8 –4.2
Newly industrialized
Asian economies 5.7 1.5 –5.6 0.8 2.2 4.5 0.4 2.0 5.7 4.4 6.3 6.1
Korea 5.1 2.2 –4.0 1.5 2.5 4.7 1.7 3.0 0.6 –0.7 2.9 3.0
Taiwan Province of China 5.7 0.1 –7.5 0.0 1.8 3.5 –2.0 1.0 8.6 6.4 9.7 10.7
Hong Kong SAR 6.4 2.5 –4.5 0.5 2.0 4.3 1.0 1.0 12.3 14.2 7.2 5.2
Singapore 7.8 1.1 –10.0 –0.1 2.1 6.5 0.0 1.1 23.5 14.8 13.1 11.2
1Movements in consumer prices are shown as annual averages. December/December changes can be found in Table A7 in the Statistical

2Percent of GDP.
3Consists of developing Asia, the newly industrialized Asian economies, and Mongolia.
4Includes Maldives, Nepal, and Sri Lanka.

is a smaller share of the economy, particularly India has less room to ease macroeconomic poli-
after factoring in its high import content. Sec- cies, growth is expected to decline sharply from
ond, the government has acted aggressively to more than 9 percent in 2007 to 4½ percent
provide major fiscal stimulus and monetary eas- in 2009. The slowdown is primarily a result of
ing, which are helping boost consumption and weaker investment, reflecting tighter financing
infrastructure investment. conditions and a turn in the domestic credit
Association of Southeast Asian Nations cycle.
(ASEAN) economies are being severely hit by The risks to the outlook for the region remain
the combined effects of lower global demand tilted squarely to the downside. A key concern
and tighter credit conditions, although not as is that a deeper or longer recession in advanced
harshly as the advanced economies. For the economies outside Asia will reduce external
group as a whole, growth is expected to decline demand even further, with negative repercus-
from more than 6 percent in 2007 to zero sions for exports, investment, and growth. In
percent in 2009. Although these economies addition, further deterioration in global finan-
have also been hurt by the drop in global trade, cial conditions may additionally tighten financ-
the composition of their exports is less concen- ing constraints, hurting financial and corporate
trated in the durable goods that have been most sectors in the region. Moreover, the impact of
affected by the global downturn. external shocks on the corporate and financial
With trade comprising a smaller share of the sectors could be larger than currently envisaged
economy, India, like China, is less exposed to because of feedback effects: a combination of
the decline in global demand. Nevertheless, its slower global demand and difficult external
economy is still suffering from more difficult funding conditions would exert growing pres-
external financing for firms and banks. Because sure on corporate Asia, which in turn would


Table 2.3. Advanced Economies: demand, along with strong policy actions to
Current Account Positions ensure financial and corporate sector health.
(Percent of GDP) Much has already been done across the region,
2007 2008 2009 2010 but in many economies the policy measures
Advanced economies –1.0 –1.1 –1.0 –1.0 introduced thus far may be insufficient to coun-
United States –5.3 –4.7 –2.8 –2.8
Euro area1 0.2 –0.7 –1.1 –1.2 teract the global slump, and more action may be
Germany 7.5 6.4 2.3 2.4 needed.
France –1.0 –1.6 –0.4 –0.9
Italy –2.4 –3.2 –3.0 –3.1 Faced with a quickly deteriorating outlook,
Spain –10.1 –9.6 –5.4 –4.4 most economies have aggressively loosened
Netherlands 6.1 4.4 2.4 2.1
Belgium 1.7 –2.5 –2.4 –3.0
monetary conditions. In Japan, to address the
Greece –14.1 –14.4 –13.5 –12.6 slowdown in growth and the tightening finan-
Austria 3.2 2.9 1.3 1.3 cial conditions, the central bank has cut rates
Portugal –9.5 –12.0 –9.1 –8.8
Finland 4.1 2.5 1.0 0.6 to virtually zero, increased liquidity provision,
Ireland –5.4 –4.5 –2.7 –1.8 broadened the range of eligible collateral,
Slovak Republic –5.4 –6.3 –5.7 –5.0
Slovenia –4.2 –5.9 –4.0 –5.0 and started purchasing commercial paper and
Luxembourg 9.8 9.1 7.6 7.0 bonds to ease corporate funding pressures.
Cyprus –11.6 –18.3 –10.3 –10.1
Malta –6.1 –6.3 –5.1 –5.2 In China, the central bank has reduced inter-
Japan 4.8 3.2 1.5 1.2 est rates and reserve requirements and loos-
United Kingdom –2.9 –1.7 –2.0 –1.5
Canada 0.9 0.6 –0.9 –0.7
ened credit ceilings. In India, the policy rate
Korea 0.6 –0.7 2.9 3.0
and reserve requirements have been cut, and
Australia –6.3 –4.2 –5.8 –5.3 large liquidity injections have eased pressure
Taiwan Province of China 8.6 6.4 9.7 10.7 in money markets; foreign exchange liquidity
Sweden 8.6 8.3 6.9 7.4
Switzerland 10.1 9.1 7.6 8.1 shortages have been alleviated by easing con-
Hong Kong SAR 12.3 14.2 7.2 5.2 trols on capital inflows and introducing foreign
Czech Republic –3.2 –3.1 –2.7 –3.0
Norway 15.9 18.4 11.0 12.6 exchange swaps for banks. Other central banks
Singapore 23.5 14.8 13.1 11.2 in the region––in Cambodia, Korea, Malaysia,
Denmark 0.7 0.5 –1.2 –1.1
Israel 2.8 1.2 1.1 0.3 the Philippines, Singapore, and Thailand––
New Zealand –8.2 –8.9 –7.8 –7.0 have also cut policy (or other relevant) rates
Iceland –15.4 –34.7 0.6 –2.1
or decreased reserve requirements. In addi-
tion, they have injected liquidity into strained
Major advanced
economies –1.4 –1.4 –1.2 –1.3 money markets, drawn on reserves, and boosted
Euro area2 0.4 –0.7 –1.1 –1.1 available liquidity buffers. Notably, Korea has
Newly industrialized
Asian economies 5.7 4.4 6.3 6.1 arranged for foreign exchange swaps with the
1Calculated as the sum of the balances of individual euro area
United States, Japan, and China.
countries. Despite these actions, there is room for addi-
2Corrected for reporting discrepancies in intra-area transactions.
tional monetary easing in a number of econo-
mies. Policy rates remain high in real terms in
reduce bank credit quality and put further strain India, and further rate cuts would help bolster
on the banking sector. credit growth. Given the sharp deterioration in
The principal policy challenges are to cushion activity, additional monetary easing also seems
the effects of the crisis and achieve a sustained appropriate in economies including China,
reduction in the region’s reliance on exports as Korea, and Malaysia. In Japan, with the con-
a source of growth. These objectives will require straint of zero interest rates, the challenge will
rebalancing the region’s economies from be to implement further easing by expanding
exports and investment toward private con- and broadening the range of instruments that
sumption. The first line of defense is to provide support credit to address tightening financial
vigorous countercyclical support to aggregate conditions.


Most economies in Asia have already imple- corporate restructuring need to be strengthened
mented expansionary fiscal policies. The most to deal with corporate stress.
ambitious plans have been announced in
China and Japan. Nonetheless, there is scope
to do more to bolster domestic demand in a Europe Is Searching for a Coherent
number of economies that have fiscal room. In Policy Response
China, further measures to boost consumption Economic activity in much of advanced
would be helpful to rebalance the economy Europe had begun to contract already before
over the medium run as well as to offer short- the September 2008 financial blowout, owing
term support. These could include improve- mainly to rising oil prices. Nonetheless, the
ments in public provision of health care and initial perception was that advanced European
education, pension reform, transfers to lower- economies would escape a full-blown recession,
income groups, further investments for rural while the emerging economies would continue
development, and reduction in consumption to grow at a lower but still healthy pace, despite
and income taxes. There is also ample room their vulnerabilities. As in Asia, healthier house-
for additional fiscal support in Singapore and hold balance sheets in most major economies
Korea. Room to maneuver is more limited in and different housing and financial market
economies such as India and the Philippines, structures were considered protective factors.
which already have high levels of public debt. However, financial systems suffered a much
In Japan, the government announced a substan- larger and more sustained shock than expected,
tial new stimulus package in early April, which macroeconomic policies were slow to react,
should support activity in 2009 and 2010. With confidence plunged as households and firms
the deficit projected to be close to 10 percent drastically scaled back their expectations about
of GDP in 2009 and net debt to exceed 100 future income, and global trade plummeted
percent of GDP, room for additional stimulus is (Figure 2.3).
close to being exhausted. Attention should shift In the advanced economies, fears about
now to putting in place an ambitious medium- growing losses on U.S.-related assets at major
term plan to secure fiscal sustainability. European banks caused wholesale markets to
In the financial sector, policies need to freeze in September 2008, with a number of fail-
ensure that systems in the region remain well ing banks requiring state intervention. Initially,
capitalized and that the risks of a credit crunch problems were concentrated in a few banks, and
are minimized. To preserve financial stability, their causes varied. The macroeconomic impli-
some economies have extended deposit guar- cations were generally not considered large,
antees (Hong Kong SAR, Malaysia, Singapore, and thus fiscal and monetary policy responses
Thailand) or have raised deposit insurance were initially limited. But the problems quickly
limits (Indonesia, Philippines). A number of caused broad repercussions because of the
economies have announced measures to boost close linkages between Europe’s major financial
capital in the financial system (India, Japan) institutions and their high leverage.3 With fund-
and provide credit support to the corporate ing markets frozen, the financial crisis rapidly
sector (China, Korea). However, the authorities transformed into a crisis for the real economy
should be prepared to do more if necessary. during the fourth quarter of 2008. Remedial
More generally, it will be important to ensure
that sufficient tools exist to inject public capital
into troubled institutions and that the incentive 3Some 16 key cross-border players account for about

framework encourages early loss recognition, so one-third of European Union (EU) banking assets, hold
on average 38 percent of their EU banking assets outside
that difficulties are resolved before they spread their home countries, and operate in just under half of
to healthy banks. Furthermore, frameworks for the other EU countries (see Trichet, 2007).


Figure 2.3. Europe: Developing a Common Response1 financial policies were put in place quickly but,
as elsewhere, have not been (and still are not)
Economic sentiment has plunged, and borrowing costs have risen sharply, despite
widespread monetary easing. Soaring fiscal deficits have led to widening sovereign sufficiently comprehensive and coordinated,
risk premiums. Amid the flight from risk, exchange rates in emerging Europe have
generally depreciated. A key challenge is to avoid a disorderly unwinding of leverage,
undermining rather than reinforcing their cross-
including for western European banks, given their large cross-border exposure to country effectiveness. Equity prices took a steep
emerging Europe.
fall, and business investment has been slashed.
Consumer Confidence and IBOXX Corporate Spreads and In addition, residential investment has fallen in
130 Economic Sentiment 5 700 Private Sector Credit 12
120 0 600 BBB countries with housing booms (for example, Ire-
(left scale)
110 -5 500 10 land, Spain, and the United Kingdom). Despite
100 -10 Private sector
400 credit growth significant support from the large fall in oil
90 -15 (right scale) 8
300 AAA
prices, consumption declined toward end-2008,
80 -20
(left scale) and further cutbacks are likely as unemployment
70 Economic Consumer -25 200 6
60 sentiment
-30 100 spreads.
(right scale) (left scale)
50 -35 0 4 As a result, most advanced economies have
1985 90 95 2000 05 Mar. Jun. 2008 Apr.
09 2007 09 suffered sharp contractions since mid-2008 (see
Policy Rates Government Bond Spreads over
Table 2.1). Real GDP fell at an annual rate of
(percent change since June Germany
2008) (change in basis points since about 6 percent during the fourth quarter in
June 2008) both the euro area and the United Kingdom.
Real GDP is forecast to drop by more than
-2 4 percent in the euro area in 2009, accelerat-
50 ing only gradually thereafter and continuing to
fall for several more quarters, making this the
-6 0 worst recession since World War II. Growth is







expected to contract by about ½ percent on an

CDS Spreads 2 Exchange Rates against the Euro annual average basis in 2010; on a fourth-quar-
600 40
(change in basis points since (percent change since June 2008) ter-to-fourth-quarter basis, the turnaround is
June 2008) 30
more apparent, from a drop of more than 3½
400 percent in real GDP in 2009 to an increase of
300 about ½ percent in 2010. The recession is pro-
jected to be particularly severe in Ireland, as its
100 -20
construction boom is painfully reversed. Outside
0 -30
the euro area, the recession is expected to be







exceptionally deep in Iceland, which is receiving

Share of Foreign-Owned Banks European Banks’ Claims in IMF support following the collapse of its overex-
120 (percent of total assets, 2004) Emerging Europe 80
tended financial sector, and quite severe in the
(percent of destination 70
100 United Kingdom, which is being hit by the end
countries’ GDP)
80 of the boom in real estate and financial activ-
60 40 ity. As a result of the broad-based fall in output,
30 unemployment rates in the advanced economies
20 are projected to reach more than 10 percent in
late 2009 and climb further through 2011.
0 0

2004 05 06 07 08:





Economic activity has taken a particularly

Sources: Bank for International Settlements; European Central Bank; European
sharp turn for the worse in many emerging
Commission; Eurostat; Haver Analytics; Thomson Datastream; and IMF staff estimates. European economies (Table 2.4 and Figure 2.4).
1AUT: Austria; BEL: Belgium; BGR: Bulgaria; CZE: Czech Republic; ESP: Spain; EUR: euro
area; FIN: Finland; FRA: France; GBR: United Kingdom; GRC: Greece; HUN: Hungary; ITA: Because of their heavy reliance on all kinds of
Italy; LVA: Latvia; LTU: Lithuania; NLD: Netherlands; POL: Poland; PRT: Portugal; ROM:
Romania; SVK: Slovak Republic; SVN: Slovenia; TUR: Turkey; USA: United States.
capital inflows—notably funding from Western
2CDS: Credit default swap. banks to sustain local credit booms—these econ-


omies have been much more severely affected by Figure 2.4. Europe: Subdued Medium-Run
the financial crisis than emerging economies in Growth Prospects1
Asia. During the early stages, they held up well, Emerging European countries have grown faster than their western European peers
and sovereign credit default swap spreads moved during 2003–08. This convergence has been helped by significant capital inflows,
which have supported large current account deficits in the less rich economies.
up only gradually. However, as Western export However, current account deficits and capital inflows will diminish appreciably over
markets contracted and the flight from risk the medium run. Growth is expected to be noticeably lower and income convergence
slower in all European economies, as illustrated by the smaller intercept and flatter
became generalized during fall 2008, the out- slope of the regression in the bottom panel compared with the top one.
look for local exports, growth, and government
revenues worsened drastically, causing sovereign 9 Income Convergence, 2003–08 9
8 LTU 8

Real GDP growth 2003–08

spreads to jump from levels of about 50–100 LVA y = –0.04x + 6.79
SVK R2 = 0.44 7
basis points to 150–900 basis points. Hungary, 6 ALB TUR EST 6

(in percent)
Latvia, and Serbia have received IMF support to MKD
sustain their balance of payments, Romania has 3 HUN CYP ESP FIN 3
asked for such support, and Turkey is discussing MLT CHE NOR
2 2
the issue with the IMF. In addition, Poland is 1 PRT ITADEU 1
0 0
seeking access to a Flexible Credit Line from the 0 50 100 150 200
Per capita income in 2007 (in percent of euro area)
IMF. Other countries with smaller exposures to
Western short-term capital, including Bulgaria 20 Current Accounts and Incomes 20
15 NOR 15
and Lithuania, have struggled with the loss of 10 DEU SWE CHE 10

Current account, 2007

(in percent of GDP)
5 NLD 5
funding and foreign direct investment (FDI) ISR
but, thus far, have not needed IMF support.4 -5 MKD IRL -5
-10 ALB ESP -10
Accordingly, real GDP in the emerging econo- -15 BIH GRC ISL -15
-20 EST -20
mies is projected to contract by about 3¾ per- LVA y = 0.19x – 21.05
-25 BGR R 2= 0.50 -25
cent in 2009 and recover to about 1 percent in -30 MNE -30
-35 -35
2010, down from growth rates of 4–7 percent 0 50 100 150 200
Per capita income in 2007 (in percent of euro area)
during 2002–07. The reasons for the sharp
25 Current Account Adjustment, 2007–14 25

Current account change, 2007–14

reversal in performance include, to varying
20 y = –0.57x + 0.21 20
degrees, overheating during pre-recession MNE
LVA ISL R 2= 0.72

(in percent of GDP)

booms, excessive reliance on short-term foreign 15 15
10 EST 10
capital that funded these booms, ownership of ROM ESP
5 5
banks by distressed foreign financial institutions, CHE
0 SWE 0
and a large share of manufacturing in activity. DEU
-5 MKD -5
The fall in activity is expected to be especially NLD NOR
-10 -10
large in the Baltic economies, where fixed -40 -30 -20 -10 0 10 20
Current account in 2007 (in percent of GDP)
exchange rate regimes leave limited the room to
maneuver (Box 2.2). 6 Income Convergence, 2009–14 6
Real GDP growth, 2009–14

The downside risks around the projections 5 ALB 5

y = –0.02x + 2.99
4 4
(in percent)

for both advanced and emerging economies are R 2= 0.39

3 SVK 3
large, particularly for the latter, where external
financial constraints could worsen further. The MKD GRC
key risk is a disorderly deleveraging of large
intra-European cross-border bank exposures. LVA IRL
-1 -1
0 50 100 150 200
Per capita income in 2007 (in percent of euro area)
4The European Investment Bank, European Bank for Source: IMF staff calculations.
1See Figure 2.3 for country abbreviations. ALB: Albania; BIH: Bosnia and Herzegovina;
Reconstruction and Development, and World Bank have
CHE: Switzerland; CYP: Cyprus; DEU: Germany; DNK: Denmark; EST: Estonia;
teamed up to provide financial assistance to strengthen HRV: Croatia; MKD: Macedonia, FYR; IRL: Ireland; ISL: Iceland; MLT: Malta;
banks and support lending to the real economy. MNE: Montenegro; NOR: Norway; SER: Serbia; SWE: Sweden.


Table 2.4. Selected Emerging European Economies: Real GDP, Consumer Prices,
and Current Account Balance
(Annual percent change, unless noted otherwise)
Real GDP Consumer Prices1 Current Account Balance2
2007 2008 2009 2010 2007 2008 2009 2010 2007 2008 2009 2010
Emerging Europe 5.4 2.9 –3.7 0.8 6.2 8.0 4.7 4.2 –7.7 –7.6 –3.9 –3.4
Turkey 4.7 1.1 –5.1 1.5 8.8 10.4 6.9 6.8 –5.8 –5.7 –1.2 –1.6
Excluding Turkey 5.9 4.1 –2.9 0.3 4.5 6.5 3.3 2.5 –9.0 –8.8 –5.6 –4.4
Baltics 8.7 –0.7 –10.6 –2.3 7.3 12.2 3.6 –1.0 –18.0 –11.6 –5.4 –5.4
Estonia 6.3 –3.6 –10.0 –1.0 6.6 10.4 0.8 –1.3 –18.1 –9.2 –6.5 –5.4
Latvia 10.0 –4.6 –12.0 –2.0 10.1 15.3 3.3 –3.5 –22.6 –13.2 –6.7 –5.5
Lithuania 8.9 3.0 –10.0 –3.0 5.8 11.1 5.1 0.6 –14.6 –11.6 –4.0 –5.3
Central Europe 5.4 3.8 –1.3 0.9 3.7 4.6 2.4 2.6 –5.2 –6.1 –4.3 –3.8
Hungary 1.1 0.6 –3.3 –0.4 7.9 6.1 3.8 2.8 –6.4 –7.8 –3.9 –3.4
Poland 6.7 4.8 –0.7 1.3 2.5 4.2 2.1 2.6 –4.7 –5.5 –4.5 –3.9
Southern and south-
eastern Europe 6.1 6.1 –3.6 –0.2 5.1 8.4 4.9 3.2 –14.2 –13.8 –8.2 –5.5
Bulgaria 6.2 6.0 –2.0 –1.0 7.6 12.0 3.7 1.3 –25.1 –24.4 –12.3 –3.6
Croatia 5.5 2.4 –3.5 0.3 2.9 6.1 2.5 2.8 –7.6 –9.4 –6.5 –4.1
Romania 6.2 7.1 –4.1 0.0 4.8 7.8 5.9 3.9 –13.9 –12.6 –7.5 –6.5
Slovak Republic 10.4 6.4 –2.1 1.9 1.9 3.9 1.7 2.3 –5.4 –6.3 –5.7 –5.0
Czech Republic 6.0 3.2 –3.5 0.1 2.9 6.3 1.0 1.6 –3.2 –3.1 –2.7 –3.0
1Movements in consumer prices are shown as annual averages. December/December changes can be found in Table A7 in the Statistical

2Percent of GDP.

Such an event could make it impossible for cutting policy rates in successive steps from
many emerging economies to roll over large 5.75 percent in 2007 to 0.5 percent in 2009, and
amounts of short-term debt and could poten- is now moving to less conventional credit-easing
tially have a similar effect on some advanced measures. The response of the Swedish Riksbank
economies that have seen a significant widening has been similarly aggressive, with the policy
of sovereign risk premiums. The result could rate now also at 1 percent and further cuts
be a financial and real sector collapse in most expected. The reaction of the European Central
emerging and a few advanced economies, with Bank (ECB) came later but has since been siz-
major feedback effects on the other economies. able. Concerned about high inflation pressure,
However, there are also some upside risks: if it raised rates in July 2008 to 4.25 percent but
EU countries manage to put in place a forceful, then changed its tack, lowering rates on its main
comprehensive, and coordinated response to refinancing operations to 1.25 percent. How-
the financial sector travails, confidence and risk- ever, the effective overnight rate is closer to the
taking might recover faster than expected. 0.25 percent rate charged on the deposit facility.
Inflation pressures are subsiding fast, and With inflation projected to stay well below the
risks for sustained deflation, although still low, “below but close to 2 percent” objective over the
are rising in advanced economies as oil prices medium run, there is room to further cut the
have plummeted and demand is slumping. main refinancing rate.
Inflation in 2010––the relevant horizon for In emerging Europe, inflation rates are also
policymakers today––is expected to be between projected to drop notably, from about 8 percent
½ and 1½ percent in most advanced economies in 2008 to close to 4 percent in 2010. Consistent
(see Table 2.1). This is down from 3–4 percent with the flight from risk, exchange rates have
rates in 2008. Accordingly, monetary policy has already depreciated sharply in emerging econo-
been eased. The Bank of England moved early, mies with floating currencies, but the effects on


Box 2.2. Vulnerabilities in Emerging Economies

Housing and Credit Boom and Bust

Foreign Exchange Exposure is Strongly Linked
Numerous emerging economies, including to Market Perceived Default Risk, Regardless
several in the central and eastern Europe (CEE) of the ER Regime
area, are experiencing large increases in coun-
try risk premiums and a collapse in property Floating exchange rates
Fixed exchange rates
prices. Such a combination can have harsh eco-
nomic effects, with limited and more expensive 800
access to loans and foreign funds by households Latvia

and businesses considerably undermining eco-

Lithuania 700
nomic activity. If the shocks are accompanied

Increase in CDS spread (basis point)

by large currency depreciations, the situation
may deteriorate even more in countries that 600
have sizable balance sheet mismatches. Further-
more, even though balance sheets are currently 500
sheltered by managed exchange rate regimes in
some countries, uncertainty about the sustain-
ability of these exchange rate policies may be
driving up risk premiums. We illustrate this by
plotting increases in the credit default swap 300
spreads1 against the percentage of loans held Czech Republic
in foreign currencies2 for seven CEE countries
(first figure). 0 20 40 60 80 100
Loans in foreign currency (percent of total loans)
This box describes the mechanisms underly-
ing the boom-bust cycle in response to changes Source: IMF staff calculations.
in finance premiums using an open-economy
model structured to represent a generic CEE
economy.3 We consider two types of finance Furthermore, the economy has a sizable
premiums. First, the domestic interbank rates foreign debt and a financial system that relies
embody an exogenous premium over the world heavily on refinancing from abroad. The
rates when adjusted for expected depreciation import-to-GDP ratio is high because a significant
or appreciation. Second, households, which are share of imported goods are used to produce
net debtors, use housing wealth as collateral for goods that are exported. Prices and wages are
loans, and the retail lending spread rises in the assumed to be more flexible than in advanced
loan-to-value ratio. economies. A couple of differences among CEE
economies make them more or less vulnerable
to external shocks. The severity of the prob-
The authors of this box are Jaromir Benes, Kevin lems may be affected, in particular, by (1) the
Clinton, and Douglas Laxton. proportion of debt in foreign currencies, and
1 Increases in five-year corporate euro CDS spreads
(2) the monetary policy regime. We show how
(Bulgaria: five-year corporate U.S. dollar CDS spreads)
performance might change as the two charac-
between January 2008 and February 2009, based on
data from Bloomberg Financial Markets and IMF staff teristics vary.
estimates. To set relevant initial conditions, we first
2Bank loans to the nonfinancial sector, including
simulate a housing boom. Real estate prices rise
households, as of December 2008 (Hungary: 2008: above their fundamental levels and are believed
Q4), based on data from the national central banks
to stay high permanently. This results in lower
and IMF staff estimates.
3The details of the model can be found in Benes, loan-to-value ratios and reduced risk premiums
Clinton, and Laxton, forthcoming. on household borrowing. Both lower financing


Box 2.2 (continued)

costs and expectations of future capital gains

boost consumption, further investment in real
estate, and thereby GDP. Increases in demand Model Simulations
(Deviations from control; x-axis in quarters)
cause a rise in imports, which is financed by
foreign capital inflows. Foreign debt, therefore, Housing Shock Only Housing and Premium
builds up over time. The economy eventually
Exchange rate peg Exchange rate peg
becomes vulnerable to domestic and foreign Inflation targeting (IT) IT: 75 percent of debt in
disturbances. In the simulations, a country risk foreign currency
IT: No debt in foreign
premium shock is imposed during the collapse currency
in house prices. A house prices collapse trig- GDP (percent deviation)
1 4
gered by a world financial crises reduces the 0 0
value of collateral and raises the households’ -1
finance premium. At the same time, the country -2
-3 -8
as a whole faces increases in the risk premium -4 -12
0 10 20 30 0 10 20 30
in international financial markets.
Inflation (percentage point deviation)
House Price Correction 0.5 1
0.0 -1
We first show the simulated response to a -0.5 -2
correction in house prices under a fixed and -3
-1.0 -4
a flexible exchange rate (second figure, first -1.5 -5
0 10 20 30 0 10 20 30
column). The economy starts with a stock of
Trade Balance to GDP (percentage point deviation)
external liabilities equal to 100 percent of GDP, 1.5 6
of which 75 percent is denominated in foreign 1.0 5
currency. At the peak, house prices are, by 0.5 3
0.0 2
assumption, 20 percent above the pre-shock -0.5
level, and the correction occurs over the next -1.0
0 10 20 30 0 10 20 30
four quarters.4 GDP declines for a prolonged
Nominal Exchange Rate (percent deviation)
period as the increased cost of credit, arising 1.5 2
from the increase in the loan-to-value ratio, 1.0 0
0.5 -2
amplifies the effect on spending of the per- 0.0 -4
ceived loss in wealth. This financial sector feed- -0.5 -6
-1.0 -8
back is known as the financial accelerator.5 Lower -1.5
0 10 20 30 0 10 20 30
demand translates into a drop in inflation.
Real Exchange Rate (percent deviation)
Because the decline in income reduces demand 1.5 2
for imports, the trade balance improves. These 1.0 0
0.5 -2
changes apply whether the exchange rate is 0.0 -4
-0.5 -6
fixed or flexible. The currency regime neverthe- -1.0 -8
less makes a difference in other aspects of the -1.5 0 -10
10 20 30 0 10 20 30
adjustment process. The house price correction
Consumer Lending Rate (percentage point deviation)
implies a depreciation under the floating rate 1.0 6
regime, since the central bank would reduce 0.5 4
0.0 3
-0.5 1
4 For instance, apartment prices in Riga, Latvia, fell
-1.0 -1
0 10 20 30 0 10 20 30
by 35 percent year over year in 2008, compared with a
62 percent rise in 2006, according to Global Property Source: IMF staff estimates.
Guide (available at
5See, for example, Bernanke (2007).


its interest rate, given the lower level of output the increase then tapers off gradually (second
and inflation.6 Improvements in the trade bal- figure, second column).
ance work to balance the increased cost of debt For the flexible exchange rate, two cases are
service implied by currency depreciation. The shown: 75 percent of external debt in foreign
depreciation also results in a smaller decline in currency versus all debt in local currency only.
inflation, such that inflation does not move far The bottom panel of the second column shows
below target. the effects on the consumer lending rate.
In the fixed rate case, there can be no infla- Under the flexible exchange rate, the increase
tion target as such, and there is a substantial is greatly moderated by a cut in the policy rate,
drop in inflation below the control value. This which responds to the weakening economy.
is reflected in a steady real depreciation while In the first case, the decline in GDP, aggra-
the nominal exchange rate remains fixed. In vated by higher lending rates, is very large. At
effect, the real exchange rate has to decline for the trough, after four quarters, it is almost 6
a while. This happens quickly with the flexible percent below its control value. The recovery
rate, but slowly, via the inflation differential, takes almost four years. Inflation dips for a few
under the fixed exchange rate. Wages and quarters, and then fluctuates around the target
prices in the CEE economies are relatively flex- rate. The trade balance as a proportion of
ible; if they were as inflexible as in advanced GDP moves into a large and prolonged surplus
economies, the decline in the real rate and relative to the control. This is a necessary part
output would be more prolonged.7 The lending of the adjustment process. The depreciation
rate rises immediately under the peg, as it fully raises the domestic currency cost of foreign
reflects the increased finance premium after the debt service and erodes the services account of
collateral value falls. In the flexible case, a drop the balance of payments. At the same time, the
in the policy rate moderates the initial increase deleveraging process reduces the capital inflow.
in the cost of credit. As output recovers, policy To maintain balance of payments equilibrium
tightens, and for a while the rates overshoot the in the face of these changes, net receipts from
long-run levels. trade must rise. The increase is brought about
by the decline in domestic spending and by cur-
House Price Correction Combined with Country Risk rency depreciation.
Premium Shock The real exchange rate drops by almost 10
To illustrate the impact of a shock to the percent relative to the control after two quar-
confidence of international lenders, occurring ters. This reflects Dornbusch-type overshoot-
at the same time as the housing bust, we simu- ing, in response to the increased country risk
late an increase in the country risk premium of premium and the cut in the policy rate.9 The
500 basis points for a period of four quarters;8 currency then appreciates slowly, remaining
below the control for many quarters. The initial
depreciation implies a sharp deterioration in
6The household risk premium does not affect the
the national balance sheet such that the domes-
wholesale interbank market or the exchange market
in this model.
7For instance, the model-implied sacrifice ratio basis points (Latvia) from single- or double-digit levels
is about 1.4. For the evidence on real and nominal in 2007, according to data from Bloomberg Financial
rigidities in new EU member states, see, for example, Markets.
Gray and others (2007). 9The model contains an uncovered interest parity
8 This compares well, for example, to the increases condition, which requires the exchange rate to fall
observed in the levels of CDS spreads for some of the below its long-run value when monetary policy keeps
CEE countries. The five-year spreads have recently the interbank rate below its equilibrium value. Expec-
risen to as high as 300 basis points (Czech Republic), tations that the domestic currency will rise provide the
600 basis points (Hungary), and more than 1,000 necessary incentive to hold it.


Box 2.2 (concluded)

tic currency value of the foreign debt rises by Following an adverse shock in the foreign
about 7.5 percent of annual GDP. exchange market, the central bank faces a
When all debt is denominated in local cur- choice between stabilizing the exchange rate
rency only, there are no adverse valuation and controlling interest rates. Under the first
effects on domestic wealth. The decline in GDP option, the high interest rates raise the cost of
is much milder—about 4 percent at the trough. borrowing and increase the intertemporal price
The implications for inflation and the trade bal- of expenditures today relative to tomorrow. This
ance are also less pronounced. reduces domestic demand, with expenditures
Under the pegged exchange rate, there cut back both on domestic output and imports.
is no immediate impact on the value of the Under the other option, the intratemporal price
debt, regardless of its currency composition. of domestic output relative to foreign goods
An important assumption of the simulation is drops, redirecting demand away from imports
that the peg is fully credible; absent credibility, and toward domestic products, which improves
the shock would be more damaging. Even with export competitiveness. Judged this way, control
perfect credibility, the negative impact of the of interest rates outperforms stabilization of the
combined shock on GDP is larger than under exchange rate.
the flexible exchange rate with high foreign This analysis, however, does not consider
currency debt. And the effect on inflation is possible sources of instability that a flexible rate
much larger, as the fixed exchange rate forces might encounter, particularly if the adjustment
the required real depreciation to take place is large and rapid. Thin markets, currency
through a decline in prices. mismatches in the balance sheets of households
The difference between the two exchange and businesses, or a preponderance of short-
rate regimes is much more marked for the com- term foreign debt are cases in point.
bined shock than for the housing shock alone. In this sense, the model simulations are
This is because the cost of household borrowing more informative about preventive measures
bears the full weight of the increase in the coun- than about actions that might be taken once
try risk premium: the decision to maintain the a crisis starts. One of the main lessons for the
level of the exchange rate fixed does not allow a future is to encourage more prudent behavior
reduction in the policy rate. by avoiding rapid accumulation of debt and
by discouraging asset-liability mismatches. The
Policy Implications negative results for the exogenous shocks to
The simulation experiments suggest that key risk premiums emphasize the role the advanced
macroeconomic variables respond to finance industrialized world will play in the resolution
premium shocks better under the flexible of the crisis: restoration of financial stability
exchange rate than under the fixed rate. This in the major financial centers will help ease
does not mean, however, that flexibility is neces- the current severe financing constraints facing
sarily the better option. emerging market economies.

inflation are being contained by widening output interest rates only gradually (for example, Hun-
gaps. Because pressures for currencies to depre- gary). In Turkey, where household balance sheets
ciate have been (and remain) high and could are relatively less exposed to exchange rate depre-
destabilize household or corporate balance sheets ciations, the central bank has lowered rates quite
in countries with significant foreign-currency- forcefully.
denominated lending, some central banks have Fiscal policy has now joined monetary policy
opted to keep rates unchanged or have lowered in combating the recession in many advanced


economies, even though a number are facing solvency concerns and cross-country coordina-
constraints from tough capital market condi- tion. As elsewhere, this reflects a challenging
tions. Beyond the operation of automatic political economy. Central banks are providing
stabilizers, the European Economic Recovery liquidity at longer maturities and are accepting
Plan calls for discretionary fiscal measures to be a wide range of collateral in repurchase opera-
taken mostly at the national level and is targeted tions, including assets for which markets have
to provide stimulus of about 1½ percent of EU essentially ceased to operate. In addition, most
GDP, with roughly 1 percent foreseen for 2009 countries have adopted measures to guarantee
and ½ percent in 2010. Thus far, EU countries wholesale funding and provide support for
have generally lived up to their commitments recapitalizing banks deemed viable. However,
under this plan, which are conditional on initial U.S.-originated toxic assets still must be cleaned
deficits, public debt levels, and other factors. off bank balance sheets, which is key to rebuild-
Hence, the general government deficit of euro ing confidence in banking systems. To achieve
area countries is projected to rise from about ¾ this, countries will need to devise and coordi-
percent of GDP in 2007 to 5½ percent in 2009 nate pricing mechanisms, and the European
and 6 percent in 2010 (Table A8). Stimulus is Commission and the ECB have offered guidance
coming mainly from euro area countries that on how to achieve this. However, coordination
took advantage of the previous cyclical upswing has been far from optimal. Policymakers were
to move their budgets close to balance or into repeatedly surprised by the virulence of the
surplus by 2007, for example, Cyprus, Finland, crisis and succumbed to national reflexes to “go
Germany, and Spain. Meanwhile, Belgium, it alone” in cobbling together responses that
Ireland, and Spain have seen a sharp widening undermined rather than enhanced other coun-
of sovereign spreads—reflecting (to varying tries’ interventions, failing to live up to the May
degrees) concern about contingent liabilities 2008 Economic and Financial Affairs Council
related to policies to support the financial sec- (ECOFIN) commitments for crisis prevention,
tor––which limits their future fiscal options. management, and resolution.5
Stimulus is expected to be small or nonexistent Stanching the much broader problems that
in Greece, Italy, and Portugal––countries with are building in Europe’s financial systems—nota-
deficits close to 3 percent of GDP in 2008 and bly those related to deteriorating prospects
high public debt or elevated country risk pre- for loan books, particularly for exposures to
miums. Advanced economies outside the euro emerging Europe—requires a far more force-
area are projected to record small deficits or ful and coordinated financial policy response
surpluses, with the exception of Iceland and the to the crisis. There is an urgent need to build
United Kingdom. The U.K. deficit is projected new or enhance existing EU schemes for mutual
to reach 11 percent of GDP in 2010, reflecting assistance so as to facilitate a rapid, common
mainly automatic stabilizers and asset-price-
related revenue shortfalls rather than discretion- 5For example, blanket guarantees or public money for

ary stimulus. bank recapitalization provided by some European govern-

ments undermined bank business prospects in other
In emerging Europe, countries are faced with
countries, thus compelling their authorities to implement
an unprecedented widening of their sovereign similar measures, putting severe strain on sovereign bal-
risk premiums. With access to funding heavily ance sheets and risk premiums. At present, pressure on
banks is building to serve national markets first. These
restricted, most are not allowing automatic stabi-
come in various guises: statements by the authorities,
lizers to play freely, and none are implementing limits on the dividends subsidiaries are permitted to pay
major stimulus. their parent companies abroad, threats to exclude sub-
Financial policies have generally been forceful sidiaries or branches of foreign banks from participation
in domestic monetary policy operations if credit lines
and innovative in addressing liquidity strains are not maintained, and the establishment of national
but have lagged with respect to addressing interbank clearinghouses.


response to emerging payment difficulties in all domestic borrowing that far outstripped domes-
EU countries and ideally in any country in the tic demand for bonds or deposits. Soon after the
neighborhood of the European Union. This is crisis struck, both nonfinancial firms and banks
essential to avoid disorderly adjustment in one found it very difficult to renew funding from
country that can drag down others. The recent investors, who steered clear of anything but the
EU decision to double the limit on its emer- safest assets. Adding to the pressure, households
gency lending (to 50 billion euros) for member began to switch from domestic- to foreign-cur-
countries from emerging Europe is a welcome rency-denominated assets. Russia, Kazakhstan,
step in this direction. Belarus, and Ukraine were hit hard, with the
Looking further ahead, the current crisis has first two drawing down large amounts of foreign
underlined the importance of strengthening currency reserves to buffer the impact of the
institutional mechanisms for economic policy shock on the exchange rate. These economies
coordination and integration across the Euro- are expected to have only very limited access to
pean Union. A key lesson is that the EU finan- external financing over the near term, with the
cial stability framework needs to be revamped. exception of Russia, which should be able to bet-
Useful steps in this direction were proposed ter sustain rollover rates. Belarus and Ukraine
in the February 25, 2009, report of the de have faced difficulties meeting their external
Larosière Group. Ultimately, what is needed obligations and have received IMF financing;
is an institutional structure for regulation and Armenia and Georgia are also receiving IMF
supervision that is firmly grounded on the support, although Georgia’s arrangement pre-
principle of joint responsibility and accountabil- dates the financial crisis.
ity for financial stability, including the sharing The beginning of the financial crisis coin-
of crisis-related financial burdens. Otherwise, cided with slumping prospects for exports and
deleterious national reflexes will continue to commodity prices because of rapidly weakening
prevail during crises. activity in the advanced economies. This has
added to the pressure faced by CIS economies
with open banking systems and severely undercut
The CIS Economies Are Suffering a Triple growth prospects for the commodity export-
Blow ers, including Russia, Kazakhstan, and Ukraine,
Among all the regions of the global economy, but also the less open economies, for example,
the CIS countries are forecast to experience the Turkmenistan. Other countries, including the
largest reversal of economic fortune over the Kyrgyz Republic, Tajikistan, and Uzbekistan, are
near term. The reason is that their economies expected to suffer from falling foreign remit-
are being badly hit by three major shocks: the tances, particularly from migrant workers in
financial turbulence, which has greatly curtailed Russia. The current account balance for the area
access to external funding; slumping demand as a whole is expected to run a zero balance
from advanced economies; and the related fall in 2009, a major switch from posting a large
in commodity prices, notably for energy. current account surplus in 2007–08 (Table 2.5).
The large direct impact of the financial However, prospects differ noticeably between
market turmoil on CIS economies reflects the energy exporters and importers: the former are
abrupt reversal of foreign funding to their projected to see large current account surpluses
largest nonfinancial firms and, more impor- evaporate because of falling commodity prices,
tant, their banking systems (Figure 2.5). Prior while the latter see a sharp narrowing of their
to the crisis, all but a few economies with less external deficits because of tightening financing
externally linked financial sectors (Azerbaijan, conditions.
Tajikistan, Turkmenistan, Uzbekistan) relied Although many CIS economies are better
significantly on external funding to sustain positioned to weather a crisis than they were


in the aftermath of Russia’s 1998 debt default,

Figure 2.5. Commonwealth of Independent States (CIS):
the fallout will nonetheless be severe. Real GDP Struggling with Capital Outflows 1
in the region, which expanded by 8½ percent
in 2007, is projected to contract by just over Financial stress has seriously hit most CIS economies. Even those with current
5 percent in 2009, the lowest rate among all account and budget surpluses have suffered, mainly because of their external debt
liabilities and slumping prices for energy exports. Countries that have room to do so
emerging regions. In 2010, growth is expected are loosening fiscal policy. But with rising sovereign spreads, the room for fiscal
to rebound to more than 1 percent. With cur- stimulus has become limited. Exchange rates are depreciating. Capital flows will take
many years to recover from the shock of the crisis.
rencies under pressure, inflation is expected to
remain close to double digits in the net energy
Current Account and General Exports and External Debt, 2007
exporters, despite slowing activity. Inflation pres- 40 Government Balances, 2007 (percent of GDP) 100
sures are expected to recede more quickly for (percent of GDP) 90
30 AZE Debt 80

Current account balance

the net energy importers.
The key challenge facing policymakers in the 20 TKM
CIS is to strike the right balance between using 10 50
macroeconomic policies to buffer the effects of KGZ RUS 40
net capital outflows on activity and maintain- UKR 30
ing confidence in local currencies. With most -10 ARM KAZ
countries operating under pegged exchange GEO MDA
-20 0



-8 -6 -4 -2 0 2 4 6 8

rate regimes, monetary policymakers have had
General government balance
to choose between drawing down reserves, rais-
ing policy rates to defend pegs, and allowing
5 2007–09 General Government 5600 CDS Spreads 1200
exchange rates to depreciate. Countries that Balance (basis points)
(change as percent of GDP) Russia
could afford to, including Russia and Kazakh-
0 4200 (right scale) 900
stan, initially drew down foreign exchange
reserves. Faced with very strong pressures, how-
-5 2800 600
ever, they have since changed their tack: Russia
has allowed the ruble to depreciate substantially Ukraine
-10 1400 (left scale) 300
below its earlier band and has raised interest
rates, while Kazakhstan has opted for a step
-15 0 0
devaluation of some 18 percent (see Figure 2.5).





2007 08 Apr.

Other countries, including Ukraine and Belarus,
experienced large currency depreciations early
200 Exchange Rate per U.S. Dollar Net Capital Flows to CIS by Type 2 8
in the crisis. (index, January 2007 = 100) (percent of GDP) 6
The problem these economies face is that 180 4
rapid currency depreciation raises the effec- Ukraine 2
tive debt burden on nonfinancial firms that -2
have borrowed in foreign currency. In fact, the -4
Kazakhstan Russia
share of foreign-currency-denominated credit 120 -6
Other CIS Total
PDI -8
in domestic bank credit stretches from close countries
PPF -10
to 30 percent in Belarus and Russia, to about OPCF -12
50 percent in Kazakhstan and Ukraine, and 80 -14
2007 08 Apr. 1990 95 2000 05 10 14
to some 70 percent in Georgia. Meeting these 09

foreign currency obligations as exchange rates

Sources: Thomson Datastream; and IMF staff estimates.
depreciate has required major cutbacks in 1ARM: Armenia; AZE: Azerbaijan; BLR: Belarus; GEO: Georgia; KAZ: Kazakhstan; KGZ:

investment and employment in several of these Kyrgyz Republic; MDA: Moldova; RUS: Russia; TJK: Tajikistan; TKM: Turkmenistan; UKR:
Ukraine; UZB: Uzbekistan.
economies. By the same token, defaults would 2PDI: private direct investment; PPF: private portfolio flows; OPCF: other private capital
flows; OF: official flows.
further exacerbate already intense strains on


Table 2.5. Selected Commonwealth of Independent States Economies: Real GDP, Consumer Prices,
and Current Account Balance
(Annual percent change, unless noted otherwise)
Real GDP Consumer Prices1 Current Account Balance2
2007 2008 2009 2010 2007 2008 2009 2010 2007 2008 2009 2010
Commonwealth of
Independent States 8.6 5.5 –5.1 1.2 9.7 15.6 12.6 9.5 4.2 5.0 0.1 1.5
Russia 8.1 5.6 –6.0 0.5 9.0 14.1 12.9 9.9 5.9 6.1 0.5 1.4
Ukraine 7.9 2.1 –8.0 1.0 12.8 25.2 16.8 10.0 –3.7 –7.2 0.6 1.4
Kazakhstan 8.9 3.2 –2.0 1.5 10.8 17.2 9.5 8.7 –7.8 5.3 –6.4 1.1
Belarus 8.6 10.0 –4.3 1.6 8.4 14.8 12.6 6.0 –6.8 –8.4 –8.1 –5.6
Turkmenistan 11.6 9.8 6.9 7.0 6.3 15.0 10.0 8.0 15.4 19.6 15.7 9.2
Azerbaijan 23.4 11.6 2.5 12.3 16.6 20.8 4.0 7.0 28.8 35.5 10.8 18.4
Low-income CIS countries 14.3 8.8 2.7 7.2 12.6 15.9 7.4 7.9 8.1 12.0 1.5 5.2
Armenia 13.8 6.8 –5.0 0.0 4.4 9.0 3.6 7.2 –6.4 –12.6 –11.5 –11.0
Georgia 12.4 2.0 1.0 3.0 9.2 10.0 5.0 6.5 –19.6 –22.6 –16.4 –16.7
Kyrgyz Republic 8.5 7.6 0.9 2.9 10.2 24.5 12.4 8.6 –0.2 –6.5 –6.3 –8.4
Moldova 4.0 7.2 –3.4 0.0 12.4 12.7 2.6 4.7 –17.0 –19.4 –19.4 –16.6
Tajikistan 7.8 7.9 2.0 3.0 13.2 20.4 11.9 11.5 –11.2 –8.8 –9.7 –8.3
Uzbekistan 9.5 9.0 7.0 7.0 12.3 12.7 12.5 9.5 7.3 13.6 7.7 6.8
Net energy exporters3 8.6 5.8 –4.9 1.2 9.4 14.5 12.3 9.7 5.6 7.0 0.7 2.2
Net energy importers4 8.4 4.3 –6.1 1.3 11.4 21.3 14.2 8.7 –5.5 –8.7 –4.1 –2.8
1Movements in consumer prices are shown as annual averages. December/December changes can be found in Table A7 in the Statistical

2Percent of GDP.
3Includes Azerbaijan, Kazakhstan, Russia, Turkmenistan, and Uzbekistan.
4Includes Armenia, Belarus, Georgia, Kyrgyz Republic, Moldova, Tajikistan, and Ukraine.

bank balance sheets and diminish prospects for to tighten. Georgia and the Kyrgyz Republic
renewed credit growth. can afford to let automatic stabilizers work,
In these circumstances, public support for provided sufficient donor support is forthcom-
the banking system is critical. Countries whose ing. Azerbaijan, Kazakhstan, Russia, and Uzbeki-
banking sectors are struggling with the need to stan––all of which posted fiscal surpluses ahead
roll over foreign debt––for example, Belarus, of the crisis––have allowed automatic stabilizers
Georgia, Kazakhstan, Russia, and Ukraine––have to operate and have eased fiscal policy to sustain
already deployed remedial measures. These growth.
include provision by the central banks of ample
liquidity, public guarantees, funding for recapi-
talization (including from international finan- Other Advanced Economies Are Dealing
cial institutions), and nationalization. It will be with Adverse Terms-of-Trade Shocks
crucial to carefully assess bank balance sheets The slump in demand in the United States
with a view to writing off bad assets in a proac- and Asia and the drop in commodity prices
tive manner, determining which banks have are weighing on activity in Canada, Australia,
sound medium-run prospects, and replenishing and New Zealand. Households are also suffer-
their capital as needed, drawing on budgetary ing wealth reduction, as equity markets and, to
resources rather than central bank support. a lesser extent, house prices have fallen after
With significant public support needed for rapid rises through 2007. These economies have
banks and difficult conditions in capital markets, benefited in recent years from highly favorable
room for fiscal policy stimulus is limited in most terms of trade, owing mainly to high prices for
CIS countries. Belarus and Ukraine have needed energy, minerals, and food exports. This has


allowed these economies to grow strongly: aver- omies are raising borrowing costs and reducing
age growth rates in the five years before 2008 capital inflows across Latin America and the
typically were in the range of 2½–4 percent. Caribbean. In addition, the decline in commod-
With lower commodity prices, diminished ity prices is pounding large economies in the
household wealth, and prospects for weak region—Argentina, Brazil, Chile, Mexico, and
export demand from the United States, Europe, Venezuela, which are among the world’s major
and Asia, projections for 2009 envisage that exporters of primary products. Moreover, the
output in Canada, Australia, and New Zealand economic slump in advanced economies—espe-
will decline moderately in 2009 before pick- cially the United States, the region’s largest trad-
ing up in 2010 (see Table 2.1). Downside risks ing partner—is depressing external demand and
include the possibility of more severe declines in lowering revenues from exports, tourism, and
world demand and elevated spreads on exter- remittances. Hence, the region is suffering from
nal finance, owing to increased risk aversion by the same trifecta of shocks as the CIS economies.
foreign lenders. Risks seem greater in Australia In contrast, however, public and private balance
and New Zealand, due to their relatively high sheets were relatively strong at the outset of the
levels of external liabilities: by end-2008, net crisis in these economies, which were also less
foreign liabilities for Australia and New Zealand financially linked to advanced economies’ bank-
were over 60 and 90 percent of income, respec- ing systems. Thus, the decline in growth is gener-
tively, although most debt is in local currency or ally projected to be less extreme than in the CIS
hedged. or emerging European economies.
Fortunately, conservative monetary and fiscal The global financial crisis spread quickly to
policy management in these economies now Latin American and Caribbean markets after
leave policymakers better placed than those in mid-September 2008. Local equity markets have
other economies to mitigate further declines in sold off heavily, with the largest losses (about 25
demand. Policy rates have been cut rapidly and percent) in Argentina (Figure 2.7). Domestic
can be cut still further. These cuts and terms- currencies have depreciated sharply, especially
of-trade losses have led the exchange rates to in Brazil and Mexico, which are large commod-
depreciate substantially in nominal terms, so ity-exporting countries with flexible exchange
that commodity revenues in domestic currency rate regimes. Local banks’ funding costs have
have not declined nearly as much as world prices increased, particularly for small and medium-
(Figure 2.6). Initiatives by central banks and gov- size banks. The cost of external borrowing has
ernments, in the form of guarantees on deposits also risen, since higher spreads on sovereign
and other bank funding, have so far supported and corporate debt have been only partially
foreign credit flows, as have other measures offset by lower yields on U.S. Treasury bills,
to stabilize the financial systems. After years of and capital flows to the region dwindled in
running surpluses, fiscal positions are robust, the last quarter of 2008. Nonetheless, financial
and substantial fiscal stimulus is being provided. markets have differentiated between borrowers:
However, owing to relatively high dependence the cost of financing has increased substantially
on demand from the United States and Asia and for some countries (for example, Argentina,
on external financing, there are limits to what Ecuador, and Venezuela) but remains relatively
domestic policy measures can achieve. low for other countries with better initial posi-
tions and larger policy buffers, including Brazil,
Chile, Colombia, Mexico, and Peru. Some of
Latin America and the Caribbean Face the latter have successfully issued foreign debt
Growing Pressures in recent months.
As in the other emerging regions, financial Adverse effects on real activity did not take
sector stress and deleveraging in advanced econ- long to surface. The slump in commodity


prices has dampened growth prospects for the

region’s commodity producers (mainly Argen-
tina, Bolivia, Brazil, Chile, Colombia, Ecuador,
Figure 2.6. Canada, Australia, and New Zealand: Mexico, Peru, Trinidad and Tobago, Uruguay,
Dealing with Terms-of-Trade Shocks and Venezuela), although it has helped com-
modity importers in the Caribbean and Central
World commodity prices have fallen substantially from recent highs, but the effects
have been mitigated by exchange rate depreciation. Governments have built up
America. Furthermore, the collapse in growth
considerable room for fiscal stimulus, but larger net private external debt makes in advanced economies, particularly in the
Australia and New Zealand more vulnerable to external financing shocks.
United States, has lowered demand for exports,
weakened tourism, and lowered workers’ remit-
Commodity Price Indices
30 tances—key supports in the Caribbean and
(percent change since July 2008)
U.S. dollar Central America. With all these factors playing
National currency
out, credit growth has slowed abruptly, industrial
10 production and exports have collapsed, and
consumer confidence has plummeted across the
-10 Considering the very challenging external
environment, most countries are weathering the
storm well relative to earlier experiences with
-30 global turbulence, thanks to improvements in
policy frameworks and balance sheet positions.
Nonetheless, real GDP is forecast to contract
-50 by 1½ percent in 2009, before staging a mod-
Canada Australia New Zealand
est recovery in 2010 (Table 2.6). Domestic
demand would shrink by about 2¼ percent in
Public and External Debt Positions, 2008
(selected advanced economies)1
2009, due to more expensive and scarce foreign
140 financing, as well as lower demand for domestic
CHE 120 products. With the exchange rate acting as a
100 shock absorber, activity is projected to decline
Net foreign assets (percent of GDP)

80 modestly or even expand in a number of infla-

60 tion-targeting economies (Brazil, Chile, Peru,
Uruguay).6 The contraction is expected to be
more severe in Mexico, given its close linkages
with the U.S. economy, notwithstanding the
mitigating effect of a flexible exchange rate, in
Venezuela, and in some very small economies
AUS dependent on tourism (Antigua and Barbuda,
GRC The Bahamas, Barbados, Jamaica).
ESP -80
NZL As output gaps widen, inflation pressures are
-30 -20 -10 0 10 20 30 40 50 60 70 80 90 100 expected to subside, despite the pass-through
General government net debt (percent of GDP)
effects of currency depreciation in a number of
Sources: Haver Analytics and IMF staff calculations. countries. For the region as a whole, inflation
1Advanced economies for which 2008 data are available include: Australia (AUS), Canada
is projected to decline from 8 percent in 2008
(CAN), Germany (DEU), Greece (GRC), Japan (JPN), Netherlands (NLD), New Zealand
(NZL), Spain (ESP), Sweden (SWE), Switzerland (CHE), and United Kingdom (GBR).

6However, corporate sectors in some of these countries

have experienced large losses on off-balance-sheet posi-

tions owing to currency depreciation.


to about 6½ percent in 2009. At the same time,

the region’s current account deficit is projected
to widen to slightly more than 2 percent in 2009
Figure 2.7. Latin America: Pressures Are Growing1
(from about ¾ percent in 2008), owing to nega-
tive terms-of-trade effects.
The global financial crisis spread quickly to Latin America and the Caribbean, as local
The risks to this outlook are firmly planted equity markets sold off heavily and domestic currencies depreciated. External
to the downside. The main danger is that a borrowing costs rose sharply, especially for countries with weaker fundamentals. It
did not take long for the crisis to affect real activity. With external demand and
protracted financial deleveraging in advanced commodity prices slumping at the same time, industrial production and exports have
economies will lead to a prolonged halt in capital plummeted.

inflows, which would require an even sharper

Equity Markets Currencies
domestic adjustment. Given sizable rollover 20 (percent change since (percent change against U.S. 10
requirements, the corporate and public sectors September 12, 2008) dollar since September 12, 2008)
would be particularly vulnerable in a number of 0
countries. Moreover, a further drop in commodity 0

prices would have a deleterious effect on exports -10 -10

and growth in most countries in the region.
The overarching policy challenge is to -20
cushion the adjustment to the external shocks. -30
Given the region’s high degree of openness -40 -30
and dependence on capital flows, however, the
potential benefits of countercyclical policies
1200 EMBI Global Spreads Corporate EMBI Spreads 1500
need to be balanced against the potential costs (change in basis points since (change in basis points
of destabilizing foreign investor confidence, 1000 September 12, 2008) since September 12, 2008)
raising external borrowing costs, and reducing 800
capital flows further. Room for policy action 900
differs greatly across countries: economies with
better frameworks and larger buffers will be 400
able to offset the effects of the global crisis to 300
varying degrees, whereas other economies may
be forced to tighten policies to avoid instability. 0 0










The task of monetary and exchange rate

policy is particularly difficult. The region came
20 Industrial Production Real Exports 40
into the crisis with relatively high inflation. (percent change from a year (percent change from a year
15 earlier)
For the inflation-targeting regimes, inflation Brazil earlier)
was above the target ranges in all cases except 10
Brazil. Faced with negative shocks to capital 5

flows and demand pressure on exchange rates, 0 10

central banks in these countries refrained from -5

Latin 0
cutting rates until December, when Colombia’s -10 America Latin
America -10
central bank lowered its policy rate by 50 basis -15 Mexico
points. As the sharp deterioration in real activ- -20
1997 99 2001 03 05 07 Feb. 1997 99 2001 03 05 07 08:
ity became increasingly evident and inflation 09 Q4
started to decelerate, the central banks of
Brazil, Chile, Mexico, and Peru followed suit. Sources: Bloomberg Financial Markets; Haver Analytics; and IMF staff estimates.
1ARG: Argentina; BRA: Brazil; CHL: Chile; COL: Colombia; MEX: Mexico; PER: Peru;
Across the region, existing reserve buffers have VEN: Venezuela.
been used to alleviate currency pressures and
smooth the adjustment to the shocks. Balancing


Table 2.6. Selected Western Hemisphere Economies: Real GDP, Consumer Prices,
and Current Account Balance
(Annual percent change, unless noted otherwise)
Real GDP Consumer Prices1 Current Account Balance2
2007 2008 2009 2010 2007 2008 2009 2010 2007 2008 2009 2010
Western Hemisphere 5.7 4.2 –1.5 1.6 5.4 7.9 6.6 6.2 0.4 –0.7 –2.2 –1.6
South America and
Mexico3 5.7 4.2 –1.6 1.6 5.3 7.7 6.7 6.3 0.7 –0.3 –1.9 –1.3
Argentina4 8.7 7.0 –1.5 0.7 8.8 8.6 6.7 7.3 1.6 1.4 1.0 1.8
Brazil 5.7 5.1 –1.3 2.2 3.6 5.7 4.8 4.0 0.1 –1.8 –1.8 –1.8
Chile 4.7 3.2 0.1 3.0 4.4 8.7 2.9 3.5 4.4 –2.0 –4.8 –5.0
Colombia 7.5 2.5 0.0 1.3 5.5 7.0 5.4 4.0 –2.8 –2.8 –3.9 –3.3
Ecuador 2.5 5.3 –2.0 1.0 2.3 8.4 4.0 3.0 2.3 2.4 –3.5 –2.3
Mexico 3.3 1.3 –3.7 1.0 4.0 5.1 4.8 3.4 –0.8 –1.4 –2.5 –2.2
Peru 8.9 9.8 3.5 4.5 1.8 5.8 4.1 2.5 1.4 –3.3 –3.3 –3.2
Uruguay 7.6 8.9 1.3 2.0 8.1 7.9 7.0 6.7 –0.8 –3.6 –1.7 –2.4
Venezuela 8.4 4.8 –2.2 –0.5 18.7 30.4 36.4 43.5 8.8 12.3 –0.4 4.1
Central America5 6.9 4.3 1.1 1.8 6.8 11.2 5.9 5.5 –7.0 –9.2 –6.1 –7.1
The Caribbean5 5.8 3.0 –0.2 1.5 6.7 11.9 4.0 5.8 –1.5 –2.8 –5.1 –4.1
1Movements in consumer prices are shown as annual averages. December/December changes can be found in Table A7 in the Statistical
2Percent of GDP.
3Includes Bolivia and Paraguay.
4Private analysts estimate that consumer price index (CPI) inflation has been considerably higher.
5The country composition of these regional groups is set out in Table F in the Statistical Appendix.

domestic and external pressures could become In light of the challenging external envi-
more difficult, especially if global financial con- ronment, the premium is high on preserving
ditions deteriorate further. Nevertheless, central the smooth functioning of domestic financial
banks in countries with more flexible exchange markets. As global banks and foreign inves-
rates anchored in credible inflation-targeting tors reduce their exposure to economies in
frameworks (for example, Brazil, Chile, Colom- the region, the relative importance of domestic
bia, and Mexico) would have room to cut policy financing will increase. To avoid a full-blown
rates further, particularly if inflation continues credit crunch, it will be important to maintain
to decelerate rapidly. stable funding conditions (in domestic cur-
Room for fiscal policy to mitigate the adverse rency) and facilitate the flow of credit. Many
effects of the external shocks differs greatly countries have already taken steps to provide
across countries. Slowdowns in activity and liquidity and support credit flows, especially
declines in commodity prices are projected to the corporate sector (notably in Brazil and
to weaken fiscal positions across the region in Mexico). Several have sought IMF support,
2009. In countries with high external borrowing including under precautionary arrangements
costs and large financing requirements, policy- (Costa Rica, El Salvador), and Mexico has
makers’ ability to conduct countercyclical fiscal secured access to the new Flexible Credit Line.
policy will be severely limited. In fact, such Although domestic financial systems are now
efforts could backfire through higher borrow- more resilient than in the past, the possibil-
ing costs and greater loss of reserves. In other ity of bank problems cannot be discounted
countries, existing fiscal room is already being in some cases, given the unfavorable external
partly used, with stimulus packages announced environment. This calls for continued work
in a number of countries with lower debt levels, on improving financial safety nets and bank
including Brazil, Chile, Mexico, and Peru. resolution frameworks.


Middle Eastern Economies Are Buffering

Global Shocks
Figure 2.8. Middle East: Coping with Lower Oil Prices1
The global crisis has not spared the Middle
East. The extremely large fall in the price of The steep decline in the price of oil is hitting the region hard. As external financing
oil is hitting the region hard (Figure 2.8). The conditions have deteriorated and capital inflows reversed, many equity and property
markets have suffered substantial losses. Despite supportive policies, growth is
deterioration in external financing conditions projected to slow and inflation pressures to subside considerably in 2009. At the
and reversal of capital inflows are also taking same time, the external and fiscal balances are set to worsen sharply, as oil-exporting
countries utilize the buffers accumulated during the boom years to cushion the
a toll: local property and equity markets have impact of the crisis.
come under intense pressure across the region,
domestic liquidity conditions have deteriorated, Oil Production and Exports 35 Equity Markets 20
(millions of barrels a day) (percent change since
credit spreads have soared for some firms, finan- September 12, 2008) 10
Oil production
cial system strains have emerged in a number of Oil exports 30 0
countries, and sovereign wealth funds have suf- -10
fered losses from investments in global markets. 25

Furthermore, the substantial decline in external -30

demand (including from countries in the Gulf -40

20 -50
region) is dampening export growth, workers’
remittances, and tourism revenues (Egypt, Jor-
15 -70
dan, Lebanon). 2005 06 07 08 09 10 UAE2 Kuwait Bahrain
Saudi Arabia Qatar
Although highly expansionary policies are set
to mitigate their impact, these adverse shocks are
12 GDP Growth Inflation 30
expected to have severe negative effects on eco- (percent) (percent)
nomic activity. In the region as a whole, growth Middle East 24
9 Oil exporters
is projected to decline from 6 percent in 2008 to
2½ percent in 2009 (Table 2.7). The slowdown Oil importers 18
in growth is expected to be broadly similar in
Middle East 12
oil-producing and non-oil-producing countries,7
even though the forces behind it are quite dif- 6
ferent. Among the oil-producing countries, the Oil exporters Oil importers

sharpest slowdown is expected in the United 0 0

1990 95 2000 05 10 1990 95 2000 05 10
Arab Emirates (UAE), where the exit of external
funds (which had entered the country on specu- 30 Current Account Fiscal Balance 20
(percent of GDP) (percent of GDP)
lation of a currency revaluation) has contributed
20 Oil exporters
to a large contraction in liquidity, a sizable fall Oil exporters 10
in property and equity prices, and substantial 10 Middle East
pressure in the banking system. A major financial Middle 0
center, UAE will also suffer from the contrac- 0
tion in global finance and merger and acquisi- Oil importers
Oil importers -10
tion activity. At the other end of the spectrum is
Qatar, which is projected to grow by 18 percent -20 -20
1990 95 2000 05 10 1990 95 2000 05 10
in 2009 (up from 16½ percent in 2008), since its
production of natural gas is expected to double
Sources: Bloomberg Financial Markets; and IMF staff estimates.
this year. Among the non-oil-producing coun- 1Oil exporters include Bahrain, Islamic Republic of Iran, Kuwait, Libya, Oman, Qatar,
Saudi Arabia, United Arab Emirates, and Republic of Yemen. Oil importers include Egypt,
Jordan, Lebanon, and Syrian Arab Republic.
7The group includes Bahrain, Islamic Republic of Iran, 2United Arab Emirates.

Kuwait, Libya, Oman, Qatar, Saudi Arabia, United Arab

Emirates, and Republic of Yemen.


Table 2.7. Selected Middle Eastern Economies: Real GDP, Consumer Prices,
and Current Account Balance
(Annual percent change, unless noted otherwise)
Real GDP Consumer Prices1 Current Account Balance2
2007 2008 2009 2010 2007 2008 2009 2010 2007 2008 2009 2010
Middle East 6.3 5.9 2.5 3.5 10.5 15.6 11.0 8.5 18.2 18.8 –0.6 3.2
Oil exporters3 6.2 5.6 2.2 3.7 10.9 16.7 10.3 8.8 21.9 22.5 0.2 5.0
Iran, I.R. of 7.8 4.5 3.2 3.0 18.4 26.0 18.0 15.0 11.9 5.2 –5.2 –3.6
Saudi Arabia 3.5 4.6 –0.9 2.9 4.1 9.9 5.5 4.5 25.1 28.9 –1.8 4.5
United Arab Emirates 6.3 7.4 –0.6 1.6 11.1 11.5 2.0 3.1 16.1 15.8 –5.6 –1.0
Kuwait 2.5 6.3 –1.1 2.4 5.5 10.5 6.0 4.8 44.7 44.7 25.8 29.3
Mashreq 6.7 6.9 3.4 3.1 9.1 12.2 13.4 7.5 –1.9 –2.7 –4.4 –5.3
Egypt 7.1 7.2 3.6 3.0 11.0 11.7 16.5 8.6 1.4 0.5 –3.0 –4.1
Syrian Arab Republic 4.2 5.2 3.0 2.8 4.7 14.5 7.5 6.0 –3.3 –4.0 –3.1 –4.4
Jordan 6.6 6.0 3.0 4.0 5.4 14.9 4.0 3.6 –16.8 –12.7 –11.2 –10.6
Lebanon 7.5 8.5 3.0 4.0 4.1 10.8 3.6 2.1 –7.1 –11.4 –10.5 –10.0
Israel 5.4 3.9 –1.7 0.3 0.5 4.7 1.4 0.8 2.8 1.2 1.1 0.3
1Movements in consumer prices are shown as annual averages. December/December changes can be found in Table A7 in the Statistical
2Percent of GDP.
3Includes Bahrain, Islamic Republic of Iran, Kuwait, Libya, Oman, Qatar, Saudi Arabia, United Arab Emirates, and Republic of Yemen.

tries, Lebanon is set to experience the steepest more protracted global recession would imply
slowdown, as difficult external liquidity condi- even weaker exports, tourism, and remittances
tions raise the cost of debt servicing and the for countries in the region.
downturn in the Gulf reduces remittances. At Utilizing the buffers accumulated during the
the same time, for the region as a whole, infla- boom years, supportive policies are set to cush-
tion pressures are projected to subside quickly, ion the impact of the global crisis. In many coun-
owing to lower commodity prices, rents, and tries, high government expenditures are filling
economic activity. The current account balance the void left by the retrenchment of private sec-
of the region is expected to swing into a small tor activity (Kuwait, Libya, Oman, Qatar, Saudi
deficit. With dwindling surpluses in oil-produc- Arabia) and will be essential for growth in the
ing countries, fiscal balances are set to dete- entire region. Regarding monetary policy, cen-
riorate substantially, as revenues decline and tral banks across the region have reacted appro-
governments use the buffers accumulated during priately by providing liquidity, cutting reserve
the recent boom to sustain domestic demand by requirements, and lowering interest rates (Egypt,
maintaining ongoing investment projects. Jordan, Kuwait, Saudi Arabia, UAE). In this
As in the other regions, downside risks to the respect, countries with pegged exchange rates
outlook are considerable. First, a prolonged (Bahrain, Kuwait, Libya, Oman, Qatar, Saudi Ara-
period of global economic turmoil could bia, Syrian Arab Republic, UAE) have benefited
prompt oil exporters to reassess their long- from the continued monetary easing in the
term oil price expectations and, consequently, United States. In the financial sector, pressures
curtail their infrastructure spending plans and are building to varying degrees across the region,
oil-production-field investment, which would owing to banks’ credit exposure to slumping
cloud growth prospects for the entire region. property and stock markets and tightening exter-
Second, deepening asset price corrections would nal liquidity conditions. In countries that have
feed through to corporate and, ultimately, bank been most affected so far, policy responses have
balance sheets, placing even greater stress on been relatively swift, with authorities implement-
financial institutions in the region. Third, a ing a myriad of measures to shore up confidence


and prevent a systemic banking crisis. These have

included introducing blanket deposit insurance
(Kuwait, UAE), providing liquidity, and injecting
capital into banks (Qatar, Saudi Arabia, UAE). Figure 2.9. Africa: Hard-Won Gains at Risk
However, additional government support in this
area may be needed in a number of countries. The global financial crisis has not spared Africa, as external demand and commodity
prices have plummeted and global credit conditions have tightened, thereby raising
the cost of external borrowing and reducing capital inflows to the continent. As a
result, growth and inflation are expected to slow considerably. Fiscal and external
Hard-Won Economic Gains in Africa Are balances are set to deteriorate sharply, mainly for commodity exporters.

Being Threatened
Relatively weak financial linkages with 1400 Emerging Market Bond Net Capital Flows to Africa 10
Spreads by Type1
advanced economies have not shielded Afri- 1200 (basis points) (percent of GDP)
can countries from the global economic storm EMBI+ Total 6
(Figure 2.9). The main shock buffeting the 4
continent is severe deterioration in external 2
growth, which is reducing demand for African 600 South
Africa 0
exports and curtailing workers’ remittances. 400 Africa PDI -2
The sharp fall in commodity prices is also hit- PPF
200 OPCF -4
ting the resource-rich countries in the region OF
0 -6
2005 06 07 08 Apr. 2000 02 04 06 08 10
hard.8 Moreover, the tightening of global credit 09
conditions is reducing FDI and reversing port-
folio flows, especially to emerging and frontier 14 GDP Growth Inflation 24
(percent) (percent)
markets (Ghana, Kenya, Nigeria, South Africa, 12
Tunisia). These external shocks are causing Oil exporters
10 Oil exporters
a severe slowdown in economic activity. For 16
the region as a whole, growth is projected to 6 Africa 12
decline from 5¼ in 2008 to 2 percent in 2009 4 World 8
(Table 2.8). On average, the downturn is most 2
pronounced in oil-exporting countries (Angola, Oil importers 4
0 Oil importers
Equatorial Guinea) and in key emerging and -2 0
frontier markets (Botswana, Mauritius, South 2000 02 04 06 08 10 2000 02 04 06 08 10

Africa), which have suffered from all three

12 Fiscal Balance Current Account 16
shocks that are hitting the continent. South (percent of GDP) (percent of GDP)
9 12
Africa’s economy, for example, is projected to Oil exporters Oil exporters
contract by about ¼ percent in 2009, its low- Africa 8
est growth rate in a decade, as capital outflows Africa 4
are forcing a sharp adjustment in asset prices 0
(mainly in equity, bond, and currency markets) -3
Oil importers -4
and in real activity. -6 Oil importers
-9 -8

-12 -12
2000 02 04 06 08 10 2000 02 04 06 08 10
8The group of oil-exporting countries includes Algeria,

Angola, Cameroon, Chad, Republic of Congo, Equatorial Sources: Bloomberg Financial Markets; and IMF staff calculations.
1PDI: private direct investment; PPF: private portfolio flows; OPCF: other private capital
Guinea, Gabon, Nigeria, and Sudan. The group of non-
flows; OF: official flows.
fuel-exporting countries includes Burkina Faso, Burundi,
Democratic Republic of Congo, Guinea, Guinea-Bissau,
Malawi, Mali, Mauritania, Mozambique, Namibia, and
Sierra Leone.


Table 2.8. Selected African Economies: Real GDP, Consumer Prices, and Current Account Balance
(Annual percent change, unless noted otherwise)
Real GDP Consumer Prices1 Current Account Balance2
2007 2008 2009 2010 2007 2008 2009 2010 2007 2008 2009 2010

Africa 6.2 5.2 2.0 3.9 6.3 10.1 9.0 6.3 1.0 1.0 –6.5 –4.7
Maghreb 3.5 4.0 3.0 4.0 3.0 4.4 3.9 3.2 12.1 10.6 –2.1 –0.8
Algeria 3.0 3.0 2.1 3.9 3.6 4.5 4.6 3.4 22.6 23.2 –1.7 1.4
Morocco 2.7 5.4 4.4 4.4 2.0 3.9 3.0 2.8 0.2 –5.6 –2.5 –3.0
Tunisia 6.3 4.5 3.3 3.8 3.1 5.0 3.2 3.4 –2.6 –4.5 –2.9 –4.3
Sub-Sahara 6.9 5.5 1.7 3.8 7.2 11.7 10.4 7.1 –2.2 –1.8 –7.7 –5.9
Horn of Africa3 10.7 8.9 5.1 5.7 11.3 18.9 22.1 10.2 –10.3 –8.6 –9.4 –8.5
Ethiopia 11.5 11.6 6.5 6.5 15.8 25.3 42.2 13.3 –4.5 –5.8 –5.8 –5.8
Sudan 10.2 6.8 4.0 5.0 8.0 14.3 9.0 8.0 –12.5 –9.3 –11.6 –10.0
Great Lakes3 7.3 6.1 4.3 5.1 9.1 11.9 13.1 7.5 –4.8 –8.1 –8.6 –9.2
Congo, Dem. Rep. of 6.3 6.2 2.7 5.5 16.7 18.0 33.9 19.9 –1.5 –15.4 –26.1 –28.7
Kenya 7.0 2.0 3.0 4.0 9.8 13.1 8.3 5.0 –4.1 –6.7 –3.6 –4.6
Tanzania 7.1 7.5 5.0 5.7 7.0 10.3 10.9 5.7 –9.0 –9.7 –8.7 –8.8
Uganda 8.6 9.5 6.2 5.5 6.8 7.3 13.7 7.4 –3.1 –3.2 –6.2 –6.5
Southern Africa3 11.8 9.4 –1.7 7.2 10.1 11.6 10.3 7.6 7.0 8.1 –8.5 –4.0
Angola 20.3 14.8 –3.6 9.3 12.2 12.5 12.1 8.9 15.9 21.2 –8.1 0.1
Zimbabwe4 –6.1 ... ... . . . 10,452.6 ... ... ... –1.4 ... ... ...
West and central Africa3 5.6 4.9 2.8 3.1 4.7 10.0 10.0 7.1 1.0 0.9 –8.2 –4.9
Ghana 6.1 7.2 4.5 4.7 10.7 16.5 14.6 7.6 –11.7 –18.2 –10.9 –14.0
Nigeria 6.4 5.3 2.9 2.6 5.5 11.2 14.2 10.1 5.8 4.5 –9.0 –3.5
CFA franc zone3 4.6 4.1 2.6 3.4 1.5 7.0 3.9 3.1 –3.3 –1.1 –6.8 –5.4
Cameroon 3.5 3.4 2.4 2.6 1.1 5.3 2.3 2.0 0.8 0.4 –5.8 –5.1
Côte d’Ivoire 1.6 2.3 3.7 4.2 1.9 6.3 5.9 3.2 –0.7 2.4 1.6 –1.6
South Africa 5.1 3.1 –0.3 1.9 7.1 11.5 6.1 5.6 –7.3 –7.4 –5.8 –6.0
Oil importers 5.4 4.7 2.1 3.7 6.8 10.6 8.5 5.6 –5.0 –6.9 –6.1 –6.6
Oil exporters5 7.5 5.9 1.8 4.2 5.5 9.3 9.7 7.3 9.6 10.7 –7.0 –2.2
1Movements in consumer prices are shown as annual averages. December/December changes can be found in Table A7 in the Statistical

2Percent of GDP.
3The country composition of these regional groups is set out in Table F in the Statistical Appendix.
4No data are shown for 2008 and beyond. The inflation figure for 2007 represents an estimate.
5Includes Chad and Mauritania in this table.

The deep downturn in economic activity to deteriorate by about 5¾ percentage points,

across the region and the sharp decline in food to a deficit of 4½ percent of GDP in 2009. This
and fuel prices will temper inflation pressures. is mainly as a result of a large swing in the
Nevertheless, for the region as a whole, infla- fiscal balances of some oil-exporting countries
tion is projected to decrease only gradually (Angola, Republic of Congo, Equatorial Guinea,
from 10 percent in 2008 to 9 percent in 2009, Nigeria). The current account balance of the
since the pass-through of commodity price region is also projected to worsen, from a sur-
changes to consumer prices is more limited plus of 1 percent in 2008 to a deficit of 6½ per-
than in advanced economies. cent of GDP in 2009. Again, the deterioration
At the same time, fiscal and external bal- is projected to be most pronounced (in double
ances are expected to deteriorate substantially. digits) for many commodity exporters (Algeria,
As commodity-based revenues dwindle, the Angola, Gabon, Equatorial Guinea, Nigeria),
overall fiscal position of the region is projected as both export volumes and prices suffer. With


global credit conditions remaining tight, the less exchange rate flexibility—in the West
financing of external deficits is expected to Africa Economic Monetary Union (WAEMU)
remain strained in a number of emerging and and the Economic Union of Central African
frontier markets (Ghana, Nigeria, South Africa, Countries (CEMAC), for instance—there
Tanzania). could be some limited room for policy eas-
As in all other regions, the risks to the ing, given the ECB’s policy decisions, falling
outlook remain tilted to the downside. The inflation, weakening demand, and, especially
main danger stems from a deeper and more regarding the CEMAC, existing reserve
prolonged slump in global growth, which buffers. In this regard, the new facility set
would lower export demand, decrease tourism up by the central bank in the WAEMU area
revenues, and further dampen workers’ remit- has been helpful in alleviating the liquidity
tances. The global credit crunch could also squeeze in domestic markets.
reduce FDI and portfolio inflows much more • In the financial sector, given the potential for
than currently expected. Moreover, domestic knock-on effects from the slowdown in real
banking systems could be weakened over time activity, efforts should focus on monitoring
from a deterioration in credit quality (owing to closely the balance sheets of financial institu-
the growth slowdown), losses on financial assets, tions and preparing to act promptly if neces-
and capital repatriations by (foreign-owned) sary. In this regard, it will be important to
parent banks. Most important, in the absence of clarify bank intervention powers and be ready
well-functioning safety nets, the crisis could lead to introduce deposit insurance schemes as
to a significant increase in poverty in a number needed.
of countries. Although a number of countries have policy
Against this backdrop, the key priority for room to maneuver, others face very tight external
policymakers must be to contain the adverse and domestic financing constraints. For the latter
impact of the crisis on economic growth and group, additional donor support is critical to
poverty, while preserving the hard-won gains of limit the social fallout of the crisis and preserve
recent years, including macroeconomic stability the hard-won gains in macroeconomic stability.
and debt sustainability. Specifically,
• Fiscal policy should, to the extent possible,
cushion the pernicious effects of the crisis. References
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• Monetary and exchange rate policy can play Exchange Rates,” IMF Working Paper (Washington:
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This chapter examines recessions and recoveries in Many aspects of the current crisis are new and
advanced economies and the role of countercyclical unanticipated.1 Uniquely, the current disrup-
macroeconomic policies. Are recessions and recoveries tion combines a financial crisis at the heart
associated with financial crises different from others? of the world’s largest economy with a global
What are the main features of globally synchronized downturn. But financial crises—episodes during
recessions? Can countercylical policies help shorten which there is widespread disruption to finan-
recessions and strengthen recoveries? The results cial institutions and the functioning of financial
suggest that recessions associated with financial markets—are not new.2 Nor are globally syn-
crises tend to be unusually severe and their recoveries chronized downturns. Therefore, history can be
typically slow. Similarly, globally synchronized reces- a useful guide to understanding the present.
sions are often long and deep, and recoveries from To put the current cycle in historical per-
these recessions are generally weak. Countercyclical spective, this chapter addresses some broad
monetary policy can help shorten recessions, but its questions about the nature of recessions and
effectiveness is limited in financial crises. By contrast, recoveries and the role of countercyclical poli-
expansionary fiscal policy seems particularly effective cies. In particular,
in shortening recessions associated with financial cri- • Are recessions and recoveries associated with
ses and boosting recoveries. However, its effectiveness financial crises different from other types of
is a decreasing function of the level of public debt. recessions and recoveries?
These findings suggest the current recession is likely • Are globally synchronized recessions different?
to be unusually long and severe and the recovery slug- • What role do policies play in determining the
gish. However, strong countercyclical policy action, shape of recessions and recoveries?
combined with the restoration of confidence in the To shed light on these questions, this chap-
financial sector, could help move the recovery forward. ter examines the dynamics of business cycles
over the past half century. It complements

he global economy is experiencing the existing literature on the business cycle along
deepest downturn in the post–World several dimensions.3 These include a compre-
War II period, as the financial crisis hensive study of recessions and recoveries in
rapidly spreads around the world (see 21 advanced economies,4 a classification of
Chapters 1 and 2). A large number of advanced
economies have fallen into recession, and 1For detailed accounts of the financial aspects of this
economies in the rest of the world have slowed crisis, see IMF (2008), Greenlaw and others (2008), and
abruptly. Global trade and financial flows are Brunnermeier (2009).
2A classic analysis of financial crises is Kindleberger
shrinking, while output and employment losses
(1978). Reinhart and Rogoff (2008b) show that finan-
mount. Credit markets remain frozen as bor-
cial crises have occurred with “equal opportunity” in
rowers are engaged in a drawn-out deleveraging advanced and less advanced economies.
3In particular, this work builds on Chapter 3 of the
process and banks struggle to improve their
financial health. April 2002 World Economic Outlook, Chapter 4 of the Octo-
ber 2008 World Economic Outlook, and Claessens, Kose, and
Terrones (2008).
Note: The main authors of this chapter are Marco 4The sample includes the following countries: Australia,

E. Terrones, Alasdair Scott, and Prakash Kannan, with Austria, Belgium, Canada, Denmark, Finland, France,
support from Gavin Asdorian and Emory Oakes. Francis Germany, Greece, Ireland, Italy, Japan, Netherlands, New
Diebold and Don Harding provided consultancy support. Zealand, Norway, Portugal, Spain, Sweden, Switzerland,
Jörg Decressin was the chapter supervisor. United Kingdom, and United States.


recessions based on their underlying sources, • Fiscal stimulus appears to be particularly help-
and an assessment of the impact of fiscal and ful during recessions associated with financial
monetary policies in recessions and recoveries. crises. Stimulus is also associated with stronger
Similar to most other studies in this area, the recoveries; however, the impact of fiscal policy
chapter makes extensive use of event analysis on the strength of the recovery is found to be
and statistical associations. smaller for economies that have higher levels
The main findings of the chapter related to of public debt.
common elements across business cycles are as This suggests that in order to mitigate
follows: the severity of the current recession and to
• Recessions in the advanced economies over strengthen the recovery, aggressive monetary
the past two decades have become less fre- and particularly fiscal measures are needed to
quent and milder, whereas expansions have support aggregate demand in the short term,
become longer, reflecting in part the “Great but care must be taken to preserve public debt
Moderation” of advanced economies’ business sustainability over the medium run. Even with
cycles. such measures, a return to steady economic
• Recessions associated with financial crises have growth depends on restoring the health of
been more severe and longer lasting than the financial sector. Indeed, one of the most
recessions associated with other shocks. Recov- important lessons from the Great Depression,
eries from such recessions have been typically and from more recent episodes of fi nancial
slower, associated with weak domestic demand crisis, is that restoring confidence in the finan-
and tight credit conditions. cial sector is key for recovery to take hold (see
• Recessions that are highly synchronized Box 3.1).
across countries have been longer and deeper The chapter is structured as follows. The
than those confined to one region. Recover- first section presents key stylized facts on
ies from these recessions have typically been recessions and recoveries for the advanced
weak, with exports playing a much more lim- economies during the past 50 years. The
ited role than in less synchronized recessions. second section reviews the key differences
The implications of these findings for the across recessions and recoveries resulting from
current situation are sobering. The current different types of shocks and different degrees
downturn is highly synchronized and is associ- of synchronization. Particular attention is paid
ated with a deep financial crisis, a rare combi- to the influence of financial crises. The third
nation in the postwar period. Accordingly, the section analyzes the effects of discretionary
downturn is likely to be unusually severe, and monetary and fiscal policies on the severity of
the recovery is expected to be sluggish. It is not recessions and on the strength of recoveries.
surprising, therefore, that many commentators It also examines how the level of public debt
looking for historical parallels for the current conditions the effectiveness of fiscal policy.
episode focus on the Great Depression of the The last section places the current downturn
1930s, by far the deepest and longest recession in historical perspective and discusses some
in the history of most advanced economies (dis- policy implications.
cussed further in Box 3.1).
Regarding policies, these are the main
findings: Business Cycles in the Advanced
• Monetary policy seems to have played an Economies
important role in ending recessions and To put the current recession in historical
strengthening recoveries. Its effectiveness, perspective, we first identify the features of
however, is weakened in the aftermath of a prior cycles. Each cycle is divided into two main
financial crisis. phases: a recession phase, characterized by a


Box 3.1. How Similar Is the Current Crisis to the Great Depression?

The current global crisis is the most severe Activity and Prices during the Great Depression
financial crisis since the Great Depression, (1929 = 100)
which invites comparisons with this historical
precedent. This box compares the current crisis
United States United Kingdom
with the Great Depression, with a particular
Germany France
focus on the unique financial conditions prevail-
ing at the onset of each event.1
Industrial Production 140
From a U.S. Recession to the Great Depression
The Great Depression remains the most
severe recession on record in the United States 100

and many other countries (first figure). Output

fell sharply, unemployment skyrocketed, and
prices fell in a deflationary spiral. There is 60
broad agreement about the process by which
a severe recession in the United States evolved 1929 30 31 32 33 34 35 36 37
into a global depression:2
• A recession began in the United States in Wholesale Prices 110
August 1929. A tightening of monetary policy
during the previous year, aimed at stemming
stock market speculation, is widely seen as 90
the initial cause. The stock market crashed 80
in October 1929, which prompted a sharp
decline in consumption, partly because of
increased uncertainty about future income. 60
• The recession intensified and turned into a 50
1929 30 31 32 33 34 35 36 37
depression over the course of 1931–32. Perni-
cious feedback loops between the financial
Sources: Mitchell (2003, 2007).
sector and the real economy emerged, lead-
ing to entrenched debt deflation3 and four
waves of bank runs and failures between 1930 • The U.S. downturn exerted contractionary
and 1933. Private consumption and invest- effects on a worldwide scale. The stock mar-
ment contracted sharply. ket crash led to price falls and wealth losses
elsewhere, while declining U.S. aggregate
demand had an adverse international effect
through trade channels. Moreover, the finan-
The main author of this box is Thomas Helbling. cial crisis in the United States spread directly
1Bordo (2008), Eichengreen (2008), and Romer
to the rest of the world through a number of
(2009) also undertake historical comparisons. channels, including diminished U.S. capital
2See Bernanke (1993), Romer (1993), Calomiris
outflows. The gold exchange standard prevail-
(1993), Eichengreen (1992), and Temin (1989, 1993).
3Declining prices of goods and services increase the ing at the time is widely seen as a major trans-
real burden of nominal debt and impair the credit- mission channel, as gold outflows into the
worthiness of borrowers, which reduces their ability to United States led to a tightening of domestic
borrow (or refinance) and spend, thereby reinforcing monetary conditions in other countries.
the contraction in aggregate demand and downward
There is broad agreement that the lack of a
pressure on prices (Fisher, 1933). This, in turn, also
reduces the creditworthiness of financial intermediar- coherent macroeconomic policy response in
ies because of increased credit risk. the United States and many other countries was


Box 3.1 (continued)

an important contributing factor to the severity ever, while the credit boom in the 1920s was
and duration of the global depression.4 Policies largely specific to the United States, the boom
helped to generate a recovery when, in early during 2004–07 was global, with increased lever-
1933, the administration of the newly elected age and risk-taking in advanced economies and
president, Franklin Roosevelt, embarked on in many emerging economies. Moreover, levels
reflationary policies that succeeded in turning of economic and financial integration are now
around deflation expectations and bolstering much higher than during the interwar period,
confidence in the banking system (see below).5 so U.S. financial shocks have a larger impact on
global financial systems than in the 1930s.7
Comparisons with the Current Crisis On the other hand, global economic condi-
In comparing the current crisis with the Great tions were weaker in mid-1929. Germany was
Depression, it is useful to distinguish between already in a recession, and wholesale and, to a
initial conditions, transmission, and policy lesser extent, consumer prices had stagnated
responses. An important common feature is that or were already falling in Germany, the United
the U.S. economy is the epicenter of both crises. Kingdom, and the United States before the
Given its weight, a downturn in the United onset of the U.S. recession. Downward pressure
States has all but guaranteed a global impact. on prices from slowing activity thus led almost
This sets the current crisis and the Great immediately to deflation. In contrast, inflation
Depression apart from many other financial in mid-2008 was above target in most econo-
crises, which have typically occurred in smaller mies, thereby providing some initial cushion.
economies and had more limited global impact. Liquidity and funding problems of banks
In both episodes, rapid credit expansion and and other financial intermediaries play a key
financial innovation led to high leverage and role in the financial sector transmission in both
created vulnerabilities to adverse shocks.6 How- episodes. The specific mechanics differ, though,
given the evolution in the structure of the finan-
cial system since the 1930s.
4Friedman and Schwartz (1963) famously argued In the Great Depression, liquidity and fund-
that the severity of the Great Depression could be ing pressures arose from the erosion of the
attributed to monetary policy mistakes—the Federal deposit base. Depositors were concerned about
Reserve failed to counter the tightening in monetary
the declining net worth of their banks, and in
conditions from bank failures and increased cash-
to-deposit ratios. Although subsequent research has the absence of deposit insurance, they withdrew
qualified some of Friedman and Schwartz’s findings, their deposits—the banks’ main external fund-
the thrust remains relevant (see, for instance, Calo- ing source. There were four waves of bank runs.
miris, 1993). Overall, about a third of all U.S. banks failed
5See, for example, Eggertsson (2008), Romer
during 1930–33. Such bank failures and losses
(1990), and Temin and Wigmore (1990).
6In both cases, financial innovation accompanied also played an important role in other econo-
the boom. In the 1920s, household credit expanded mies.8 In particular, the failure of the Austrian
more rapidly than personal income in the United bank Creditanstalt in 1931, which had more
States, because the rapid diffusion of mass consumer
durables was associated with rapid growth in install-
ment credit provided by nonbank financial institu- 7There was room, however, for cross-border
tions (Eichengreen and Mitchener, 2003). At the same financial feedback from the precarious international
time, new marketing techniques for stocks helped to financial conditions in mid-1929. Major European
broaden equity ownership, while investment trusts and economies depended on capital inflows from the
individuals increasingly used margin loans to lever- United States to maintain fixed exchange rates
age their equity market investment. In the current under the gold standard prevailing at the time. U.S.
episode, financial innovation centered on mortgage- monetary policy tightening in 1928 had already led to
related products, both in origination and distribution some slowing of these flows (Kindleberger, 1993).
(securitization, structured products). 8See Kindleberger (1993) and Temin (1993).


than half of all the deposits in the country’s

banking system on its books, set the scene for
Financial Factors at Work in the United
States, Now and Then1 bank runs in other European countries, includ-
(Months from business cycle peak on x-axis) ing Germany. These failures were related to ear-
lier gold losses and fears that countries would
July 1929 December 2007
exit from the gold standard in an environment
Baa Corporate Bond Spread2 6 where nonresident deposits were an important
October 1930, funding source for many European banks.
first wave of bank 5 In the current crisis, the reassurance provided
4 by deposit insurance has largely prevented
bank runs by retail depositors. However, fund-
3 ing problems have arisen for banks and other
intermediaries reliant on wholesale funding in
0 2 4 6 8 10 12 14 16 18 20 22 24 short-term money markets, particularly those
Net Credit Extension3 3 issuing or holding (directly and indirectly) U.S.
(percent of personal income) mortgage securities and derivatives.9 The main
2 reason for the erosion of the funding base was
concern about the net worth of intermediaries
after losses from increasing mortgage defaults
0 in the United States, especially after Lehman
Brothers’ closure implied significant losses for
0 2 4 6 8 10 12 14 16 18 20 22 24 its creditors. With large cross-border linkages
Loan Ratios4 0.90
in short-term money markets, these funding
(percent) problems were international in reach early on
0.85 in this crisis.
Despite the differences in mechanics, the
effects on the behavior of financial intermediar-
0.75 ies are similar. Funding problems have led to
balance sheet contraction (deleveraging), fire
0.70 sales of assets (adding to downward pressure on
0 2 4 6 8 10 12 14 16 18 20 22 24
prices), increased holdings of liquid assets, and
Stock Prices (S&P) decreased lending (or holdings of risky assets)
(business cycle peak = 100) 120
110 as a share of total assets. Moreover, with today’s
100 highly interconnected financial system, there
has been gridlock because of network effects
70 in a world of multiple trading and large gross
60 positions.
50 The ultimate effects of these financial factors
0 2 4 6 8 10 12 14 16 18 20 22 24 on the real economy are similar in the two epi-
Sources: Bernanke (1983); Federal Reserve Board; and Haver sodes. They reduce the availability of external
Analytics. funds for borrowers and raise the marginal costs
1 Business cycle peaks as determined by the National Bureau of
Economic Research. of funds (see, for instance, Bernanke, 1983). At
2Average yield on Baa-rated corporate bonds over yield on
the same time, losses from falling asset prices,
long-term treasuries.
3 Monthly changes in commercial bank loans. together with losses from business operations,
4 Loan-to-deposit ratio in 1929–31, loan-to-asset ratio in
2007–09 (adjusted by a constant to match the June 2009 initial
9See Brunnermeier (2009) and Gorton (2008).


Box 3.1 (concluded)

lower the net worth of borrowers, thereby

reducing their creditworthiness as well as that of Countercyclical Policies and Output-Inflation
related financial intermediaries.
In the U.S. financial system, the paths of sev-
United States: Money Stock (M1)
eral financial variables are remarkably similar in (100 at t = 0; business cycle peak at t = 0; months on 120

both events (second figure).10 Bond spreads for x-axis)

average borrowers increase; the net extension
of bank credit slows, partly reflecting declining
loan-to-deposit or loan-to-asset ratios with bal- 105

ance sheet adjustment; and stock prices decline 100

at a similar pace.

Policy Responses Then and Now 90

0 4 8 12 16 20 24
Countercylical policy responses were virtually
absent in the early stages of the Great Depres- United States: Industrial Production and
sion, reflecting in part a “gold standard mental- Consumer Prices
(year-over-year percent change) 8
ity” focused on traditional policies for stability December 6
(stable gold reserves and balanced budgets). 2007 4

Consumer Prices
Over time, however, a growing number of coun-
tries ended gold convertibility and/or changed -2
the gold parity of their currencies—including First wave of bank July
runs and failures 1929
Great Britain in September 1931 and the United -6
(October 30, 1930)
States in April 1933. These regime changes July
1931 -10
set the stage for significant monetary expan- -12
-30 -25 -20 -15 -10 -5 0 5 10 15 20
sions and are widely credited for initiating the
Industrial production
recoveries. In the United States, the Emergency
Banking Act of March 1933 allowed for the clos- Sources: Bernanke (1983); Friedman and Schwarz (1963); and
ing of insolvent banks and the restructuring of Haver Analytics.
solvent banks, which boosted confidence in the
financial sector. The Banking Act of June 1933
introduced federal deposit insurance. Economic
historians generally do not see an important liquidity and lowered policy interest rates.
role for fiscal policy in the recovery because it Reflecting these policy efforts, the U.S. money
was not used on a large scale, except in Ger- stock has expanded rapidly, rather than con-
many and Japan.11 tracting as during the Great Depression (third
In the current downturn, there has been figure, first panel), and for the most part, fund-
strong, swift recourse to macroeconomic policy ing problems have not been allowed to cause
support. Major central banks have intervened the failure of systemically important financial
massively to provide financial systems with intermediaries.
In the current crisis, the international mon-
10Comparisons in this figure extend data analysis etary system is not an impediment to effective
for the United States by Bernanke (1983) to the cur- policy responses, unlike in the early 1930s, when
rent crisis. the gold exchange standard fostered deflation-
11Romer (2009) notes that while the U.S. federal
ary adjustment. At that time, the scope for
fiscal deficit rose by 1½ percentage points in 1934, expansionary monetary policy and lender-of-
the stimulus at the federal level was not sustained into
1935 and was in any case largely offset by the procycli-
last-resort operations in many European coun-
cal stance at the state and local levels. tries was hampered by the potential loss of gold


reserves and exit from gold convertibility, given cial sector adjustment seen in the early 1930s
balance of payments deficits. Conversely, in has been avoided, and declines in activity and
the major surplus countries, the United States inflation in the United States and other major
and France, the existing scope for reflationary economies have so far been less virulent than
adjustment from rising gold inflows was not during 1929–31 (third figure, second panel).
exploited.12 Moreover, in contrast with today, Debt deflation has thus been avoided so far.
there was little international cooperation, given Nevertheless, there are worrisome parallels.
political tension among the major countries, There is continued pressure on asset prices,
and increasing protectionism—including tariff lending remains constrained by financial sector
wars set off by the passage of the U.S. Smoot- deleveraging and widespread lack of confidence
Hawley Tariff Act in 1930—increased the drag in financial intermediaries, financial shocks
from falling external demand. have affected real activity on a global scale , and
In sum, unprecedented policy support, an inflation is decelerating rapidly and is likely to
international monetary system that provides approach values close to zero in a number of
for reflationary adjustment, and more favorable countries. Moreover, declining activity is begin-
initial macroeconomic conditions are the key ning to create feedback effects that affect the
features that distinguish the current crisis solvency of financial intermediaries, which risks
from the Great Depression. The traumatic finan- of debt deflation have increased. As discussed
in Chapter 1, further policy action is needed to
12See Temin (1989, 1993), Eichengreen (1992), and restore confidence in the financial sector, stop
Kindleberger (1993). The Federal Reserve sterilized damaging asset price deflation, and support an
the effects of gold inflows on the money stock. early global recovery.

decline in economic activity, and an expansion The chapter considers the two main proper-
phase. Following the long-standing tradition of ties of the cycle:
Burns and Mitchell (1946), this chapter employs • Duration: the number of quarters from peak
a “classical” approach to dating turning points to trough in a recession, or from trough to
in a large sample of advanced economies from the next peak in an expansion.
1960 to the present. It focuses on quarterly • Amplitude: the percent change in real GDP
changes in real GDP to determine cyclical peaks from peak to trough in a recession, or from
and troughs (Figure 3.1).5 trough to the next peak in an expansion.
The chapter also examines the slope of a
5The procedure used to date business cycles in this recession (or expansion), that is, the ratio of
chapter has been referred to as BBQ (Bry-Boschen amplitude to duration, which indicates the
procedure for quarterly data; see Harding and Pagan, steepness of each cyclical phase.
2002). It identifies local maximums and minimums of a
given series, here the logarithm of real GDP, that meet
the conditions for a minimal duration of a cycle and of
each phase (in this chapter, these are set at five and two Recessions and Expansions: Some Basic Facts
quarters, respectively). Alternative dating algorithms,
On average, advanced economies have
such as those developed by Chauvet and Hamilton (2005)
and Leamer (2008), are more difficult to implement experienced six complete cycles of recession
for a large sample of countries. The National Bureau of
Economic Research (NBER), which dates business cycles
in the United States, uses several measures of economic
activity to determine peaks and troughs. These measures income, industrial production, and sales. NBER dating is,
include—in addition to real GDP—employment, real however, subjective and not replicable internationally.


and expansion since 1960.6 The number of

Figure 3.1. Business Cycle Peaks and Troughs
recessions, however, varies significantly across
Each cycle has two phases: a recession phase (from peak to trough) and an countries, with some (Canada, Ireland, Japan,
expansion phase (from trough to the next peak). Norway, Sweden) experiencing only three reces-
sions and others (Italy, New Zealand, Switzer-
land) experiencing nine or more.
Peak Recessions are distinctly shallower, briefer,
and less frequent than expansions. In a typi-
cal recession, GDP falls by about 2¾ percent
level (Table 3.1).7 In contrast, during an expan-
sion, GDP tends to rise by almost 20 percent.
This illustrates mainly the importance of trend
Trough growth; the higher the long-run growth rate of
an economy, the shallower the recession and
the greater the amplitude of expansions. Some
recessions, however, are severe, with peak-to-
Trough trough declines in output exceeding 10 percent.
These episodes are often called depressions
Expansion Recession Expansion
(April 2002 World Economic Outlook). Since 1960,
there have been six depression episodes in the
t0 t1 t2 t3
advanced economies; the latest was observed
in Finland in the early 1990s. In contrast, some
Source: IMF staff calculations.
expansions witness trough-to-peak output
increases larger than 50 percent—the “Irish
miracle” being a recent example.
Figure 3.2. Business Cycles Have Moderated over Time A typical recession persists for about a year,
whereas an expansion often lasts more than five
Recessions have become less frequent and milder, whereas expansions have years. As a result, advanced economies are in a
become longer.
recession phase of the cycle only 10 percent of
Number of recessions a country the time. The longest episodes of recessions and
Output loss during recession (percent change from peak level) expansions in these countries lasted more than
Length of following expansion (quarters; right scale)
3 years and 15 years, respectively. Finland and
Sweden experienced two of the longest reces-
5 25
sions, and Ireland and Sweden experienced two
of the longest expansions.
4 20
Since the mid-1980s, recessions in advanced
economies have become less frequent and
3 15 milder, while expansions have become longer
lasting, a development associated with the Great
2 10 Moderation (Figure 3.2).8 A host of factors

1 5 6In the sample period, there are 122 completed and 15

ongoing recessions.
7Related findings are reported in the April 2002 World
0 0
1960–85 1986–2007 Economic Outlook.
8This phenomenon has been documented in several

Source: IMF staff calculations. papers, including McConnell and Perez-Quiros (2000)
and Blanchard and Simon (2001). During this period the


Table 3.1. Business Cycles in the Industrial Countries: Summary Statistics

Duration1 Amplitude2
Recession Recovery3 Expansion Recession Recovery4 Expansion
Mean (1) 3.64 3.22 21.75 –2.71 4.05 19.56
Standard deviation (2) 2.07 2.72 17.89 2.93 3.12 17.50
Coefficient of variation (2)/(1) 0.57 0.84 0.82 1.08 0.77 0.89
Number of events 122 109 122 122 112 122
By driver of recession
Financial crises
Mean (1) 5.67** 5.64** 26.40** –3.39 2.21*** 19.47
Standard deviation (2) 3.15 3.32 24.74 3.25 1.18 20.46
Coefficient of variation (2)/(1) 0.56 0.59 0.94 0.96 0.53 1.05
Number of events 15 11 15 15 13 15
Mean (1) 3.36** 2.95** 21.09** –2.61 4.29*** 19.58
Standard deviation (2) 1.71 2.52 16.77 2.89 3.22 17.15
Coefficient of variation (2)/(1) 0.51 0.85 0.79 1.11 0.75 0.88
Number of events 107 98 107 107 99 107
By extent of synchronization
Highly synchronized
Mean (1) 4.54*** 4.19* 19.97*** –3.45* 3.66** 16.24*
Standard deviation (2) 2.50 3.59 15.32 2.96 1.72 11.85
Coefficient of variation (2)/(1) 0.55 0.86 0.77 0.86 0.47 0.73
Number of events 37 32 37 37 34 37
Mean (1) 3.25*** 2.82* 22.52*** –2.39* 4.21** 21.01*
Standard deviation (2) 1.73 2.16 18.94 2.88 3.56 19.33
Coefficient of variation (2)/(1) 0.53 0.77 0.84 1.21 0.85 0.92
Number of events 85 77 85 85 78 85
Recessions associated with financial crises that are highly synchronized
Mean 7.33 6.75 24.33 –4.82 2.82 18.83
Note: The symbols *, **, and *** indicate statistical significance at the 10, 5, and 1 percent levels, respectively. Statistical significance for
recessions associated with financial crises (highly synchronized recessions) is calculated versus other recessions.
1Number of quarters.
2Percent change in real GDP.
3Number of quarters before recovery to the level of previous peak.
4Percent increase in real GDP after one year.
5Recessions not associated with a financial crisis.
6Recessions that are not highly synchronized.

may explain this, including global integration, The recovery phase of the cycle has been
improvements in financial markets, changes in an object of constant interest in policy circles.9
the composition of aggregate output toward An economy typically recovers to its previous
the service sector and away from manufactur- peak output in less than a year (see Table 3.1).
ing, and better macroeconomic policies (see Perhaps more important, recoveries are typically
Blanchard and Simon, 2001; and Romer, 1999). steeper than recessions—the average growth
Another possibility is that the Great Modera-
tion is the result of good luck, primarily reflect- 9There is no common definition of recovery. Whereas

ing the absence of large shocks to the world some define it as the time it takes for the economy to
economy. return to the peak level before the recession, others
measure it by the cumulative growth achieved after a cer-
tain time period, say a year, following the trough. In this
chapter, both definitions are used. These two definitions
average slope of a recession—a proxy for how steep or are complementary and display a sort of duality—the
abruptly output contracts—is about –0.6 percent, which first one determines the time it takes to achieve a given
is lower in absolute value than the average –1 percent for amplitude, and the second one determines the amplitude
other recession periods. observed after a given time.


per quarter during a recovery exceeds the ments in the United States often play a pivotal
rate of contraction during a recession by more role both in the severity and duration of these
than 25 percent. In fact, there is evidence of a highly synchronized recessions.
bounce-back effect: output growth during the
first year of recovery is significantly and posi-
tively related to the severity of the preceding Categorizing Recessions and Recoveries
recession. A number of factors can drive an We begin categorizing recessions and recover-
economy to bounce back, including fiscal and ies by first defining financial crises as episodes
monetary policies (this possibility is explored during which there is widespread disruption
later in the chapter), technological progress, to financial institutions and the functioning of
and population growth.10 financial markets. Financial crises are identified
using the narrative analysis of Reinhart and Rog-
off (2008a, 2008b, 2009),12 which in turn draws
Does the Cause of a Downturn Affect the on the work of Kaminsky and Reinhart (1999).13
Shape of the Cycle? Next, a recession is said to be associated with
This section associates recessions and their a financial crisis if the recession episode starts
recoveries with different types of shocks: finan- at the same time or after the beginning of the
cial, external, fiscal policy, monetary policy, financial crisis.14 Of the 122 recessions in the
and oil price shocks.11 The objective of this sample, 15 are associated with financial crises
exercise is to determine whether there have (Table 3.2).15 The other disturbances are identi-
been important differences between the reces- fied using simple statistical rules of thumb (see
sions associated with financial crises and those the appendix).16 More than half of the 122
associated with other shocks. In addition, this
section examines whether there is a difference
12An alternative method of defining financial crises is
between highly synchronized and nonsynchro-
to use a time series or some combination of series as an
nized recessions. indicator, based on some threshold (the method used
We find that different shocks are associated for the other shocks). An advantage of using a narrative-
with different patterns of macroeconomic and based method is that it avoids having to define episodes
according to characteristics of the very things one is
financial variables during recessions and recov- interested in—for example, a financial crisis could be
eries. In particular, recessions associated with defined as an episode in which there is a large reduction
financial crises have typically been severe and in credit, but that would preclude assessing the behavior
of credit during and following financial crises.
protracted, whereas recoveries from recessions 13We are particularly interested in banking crises, which
associated with financial crises have typically are defined by Kaminsky and Reinhart (1999, p. 476) as
been slower, held back by weak private demand episodes leading to bank runs or large-scale government
and credit. In addition, highly synchronized assistance to financial institutions.
14On these grounds, we omit Reinhart-Rogoff episodes
recession episodes are longer and deeper than not immediately associated with recessions—for example,
other recessions, and recoveries from these the savings and loan crisis of the early 1980s in the
recessions are typically weak. Moreover, develop- United States.
15In principle, there is a potential endogeneity problem

here, because the financial crisis could lead to a recession

10Sichel (1994) and Wynne and Balke (1993) provide and vice versa. To address this issue, the dating of crises
evidence of a bounce-back effect in U.S. business cycles. and cyclical turning points has been done using two dif-
Romer and Romer (1994) report that monetary policy ferent methods, as explained in the chapter.
has been instrumental in ending U.S. recessions and 16These rules have the advantage that they are trans-

helping recoveries during the postwar period. parent and can easily and consistently be applied to the
11Term spreads, which have often been used as an GDP series for the 21 countries in the sample. There
indicator of monetary policy stance and as a predictor of will always be cases that are not well identified by simple
short-run output growth—see, for example, Estrella and rules. However, a more thorough analysis of the nonfi-
Mishkin (1996)—were also analyzed and found to give nancial shocks for each country is outside the scope of
results very similar to those for monetary policy shocks. this chapter.


Table 3.2. Financial Crises and Associated

Australia 1990:Q2–1991:Q2
Denmark 1987:Q1–1988:Q2
Finland 1990:Q2–1993:Q2*
France 1992:Q2–1993:Q3
Germany 1980:Q2–1980:Q4
Greece 1992:Q2–1993:Q1
Italy 1992:Q2–1993:Q3
Japan 1993:Q2–1993:Q4*
Japan 1997:Q2–1999:Q1
New Zealand 1986:Q4–1987:Q4 Figure 3.3. Temporal Evolution of Recessions by Shock
Norway 1988:Q2–1988:Q4*
Spain 1978:Q3–1979:Q1*
Sweden 1990:Q2–1993:Q1* Recessions have become less common in recent years. But recessions associated
United Kingdom 1973:Q3–1974:Q1 with financial crises have become more common.
United Kingdom 1990:Q3–1991:Q3
Note: * denotes the “Big Five” financial crises (Reinhart and
Shocks in Early and Recent Years 75
Rogoff, 2008a).
1960–85 1986–2007

recessions in the sample are associated with one

or more of these shocks.17 Oil shocks are the 45

most widespread type, affecting 17 economies

in the sample. Monetary and fiscal policy shocks
are less common, and external demand shocks
are the least common of all, affecting only a
handful of the smaller and more open econo-
mies (see Table 3.5 in the appendix). Although Total Fiscal policy Monetary Oil shocks External Financial
recessions contractions policy demand crises
recessions have become less common overall tightening shocks
during the Great Moderation, those associated
with financial crises have become more common Shocks by Year
Financial crises External demand shocks Oil shocks 16
(Figure 3.3). Monetary policy tightening Fiscal policy contractions Unattributed
Summaries of the stylized facts of these differ- 14

ent categories of recessions and recoveries are 12

presented in Table 3.1 and Figure 3.4. With the 10

notable exception of oil shocks, the amplitude 8
of a recession is closely related to its duration.18 6
Recessions associated with financial crises are
longer and generally more costly than others;
those associated with the “Big Five” financial
crises identified by Reinhart and Rogoff (2008a) 1960 65 70 75 80 85 90 95 2000 05
were particularly costly (Figure 3.4, upper
Source: IMF staff calculations.

17The scores often coincide, with 105 scores for the 65

recessions that are associated with these shocks, which

indicates how misleading it can be to talk about a reces-
sion as a result of a single “cause.”
18Overall, oil shocks typically lead to recessions that are

very costly but relatively short lived. This is particularly

true of the 1973–74 oil shocks, after which GDP growth
bounced back relatively quickly.


panel).19 Financial crises are also followed by

weak recoveries: the time taken to recover to the
level of activity reached in the previous peak is
Figure 3.4. Average Statistics for Recessions and
as long as the recession itself, whereas cumula-
tive GDP growth in the four quarters after the
The severity of most recessions is closely related to their duration. Recessions trough is typically lower than following other
following financial crises are longer than average. Recessions following oil types of recessions (Figure 3.4, lower panel).20
shocks are relatively severe but not very long. The bounce-back from financial
crises is weaker than average. The time for output to recover to the level of the Note that the cumulative growth one year after
previous peak is longer. the trough for a financial crisis is 2½ percentage
points lower than in other cases, after control-
ling for the severity and duration of the previous
Duration (quarters)
Output loss (percent from peak)

Fiscal policy
Why Are Financial Crises Different?
Monetary policy
What are the mechanisms that differenti-
ate recessions and recoveries associated with
Oil shocks financial crises? An answer to this question
needs to take into account the nature of the
External demand expansions that preceded these recessions.
Narrative evidence indicates that these episodes
Financial crises have often been associated with credit booms
involving overheated goods and labor markets,
“Big Five” house price booms, and, frequently, a loss of
financial crises
external competitiveness.21 This can be seen in
0 1 2 3 4 5 6 7 Figure 3.5, which shows median values of mac-
roeconomic variables during the eight quarters
Output gain after four quarters (percent from trough) before the peak in GDP. Credit growth during
Time until recovery to previous peak (quarters) the expansions preceding financial crises is
higher than during other expansions, and this is
Fiscal policy
associated with higher-than-usual consumption
as a share of GDP leading up to the peak. Rela-
Monetary policy
tive to other expansions, labor market partici-
pation is high, nominal wage growth is high,
Oil shocks and unemployment is low. Price increases—for
example, the GDP deflator, house prices, and
External demand
equity prices—are all noticeably higher than

Financial crises 19The Big Five financial crisis episodes include Finland

(1990–93), Japan (1993), Norway (1988), Spain (1978–

“Big Five” 79), and Sweden (1990–93).
financial crises 20Recessions and recoveries are clearly different in

0 1 2 3 4 5 6 7
terms of their severity, depending on the type of shock
associated with them. But, for the same shock, they are
also roughly symmetric—the slope of the recession phase
Source: IMF staff calculations.
is closely matched by the slope of the recovery phase.
21For a comprehensive analysis of credit booms in the

advanced and emerging economies, see for instance

Mendoza and Terrones (2008).


usual. Credit booms have frequently followed

financial deregulation.22 There is some evidence Figure 3.5. Expansions in the Run-Up to Recessions
of asset price bubbles: in the period leading up Associated with Financial Crises and Other Shocks
to financial crisis episodes, the ratio of house (Median = 100 at t = –8; peak in output at t = 0; quarters on the x-axis)
prices to housing rental rates rises above that
during other recession episodes, starting from Expansions associated with financial crises show overheating in goods, labor, and
asset markets.
levels well below (Figure 3.6).
Rapid credit growth has typically been Financial crises All other recessions
associated with shifts in household saving rates
and a deterioration of the quality of balance 125 Credit1 Consumption1 100.6
(share of GDP)
sheets.23 The upper panel of Figure 3.7 shows 120 100.4
that household saving rates out of disposable 115
income have been noticeably lower in expan- 110
sions before financial crises. However, after 100.0
a financial crisis strikes, saving rates increase 99.8
substantially, especially during recessions. In the
95 99.6
Big Five episodes, the turnaround in household -8 -6 -4 -2 0 -8 -6 -4 -2 0
saving rates was larger still. Data for net lend-
ing paint a complementary picture (Figure 3.7, 101.4 Labor Force Participation Rate Unemployment Rate 100.2
lower panel). Although these data cover only a
101.0 100.0
few of the financial crisis episodes under con- 100.8
sideration here, patterns from some of the most 100.6 99.8
relevant episodes—Denmark (1985–89), Finland 100.4
(1988–92), Norway (1986–90), and the United 100.2 99.6
Kingdom (1988–92)—show that households’ net
99.8 99.4
lending balances increased substantially during -8 -6 -4 -2 0 -8 -6 -4 -2 0

120 Nominal Wages GDP Deflator 115
Taken together, the behavior of these vari-
ables suggests that expansions associated 115
with financial crises may be driven by overly 110
optimistic expectations for growth in income 105
and wealth.24 The result is overvalued goods,
services, and, in particular, asset prices. For a 100

95 95
-8 -6 -4 -2 0 -8 -6 -4 -2 0
22For example, Table 3.6 in the appendix shows that
almost all of the 15 financial crises considered here fol- 120 House Prices1 Equity Prices1 115
lowed deregulation in the mortgage market.
23Unfortunately, comprehensive balance sheet data are 115 110
not available for most of the financial crisis episodes. But,
as an example, analysis of data for the United Kingdom 110 105
shows a pronounced deterioration in the ratio of total 100
household liabilities to liquid assets in the years before
the recession of 1990–91, with a gradual recovery in the 100 95
quality of household balance sheets during and after the
recession. 95 90
-8 -6 -4 -2 0 -8 -6 -4 -2 0
24In fact, real GDP growth rates before recessions

associated with financial crises have not been exception-

Source: IMF staff calculations.
ally high compared with those before other recessions. 1Data in real terms.
Similarly, the relationship between the average level of
the output gap in the four quarters before the peak and


period, this overheating appears to confirm the

optimistic expectations, but when expectations
are eventually disappointed, restoring household
balance sheets and adjusting prices downward
toward something approaching fair value
require sharp adjustments in private behavior.
Not surprisingly, a key reason recessions associ-
ated with financial crises are so much worse is
the decline in private consumption.
Turning to the recovery phase, the weakness
in private demand tends to persist in upswings
Figure 3.6. House Price-to-Rental Ratios for Recessions that follow recessions associated with financial
Associated with Financial Crises and Other Shocks crises (Figure 3.8). Private consumption typically
(Peak in output at t = 0; quarters on the x-axis)
grows more slowly than during other recoveries.
Private investment continues to decline after
Expansions before recessions associated with financial crises show rapid rises in
house price-to-rental ratios. The ratio declines steeply in recessions.
the recession trough; in particular, residential
investment typically takes two years merely to
Financial crises All other recessions stop declining. Thus, output growth is sluggish,
and the unemployment rate continues to rise
by more than usual. Credit growth is faltering,
whereas in other recoveries it is steady and
strong. Asset prices are generally weaker; in par-
ticular, house prices follow a prolonged decline.
On the other hand, although the recovery of
1.00 domestic private demand from financial crises
is weaker than usual, economies hit by finan-
cial crises have typically benefited from rela-
0.95 tively strong demand in the rest of the world,
which has helped them export their way out of
0.90 What do these observations tell us about the
dynamics of recovery after a financial crisis?
First, households and firms either perceive a
-8 -6 -4 -2 0 2 4 stronger need to restore their balance sheets
after a period of overleveraging or are con-
Source: Organization for Economic Cooperation and Development. strained to do so by sharp reductions in credit
supply. Private consumption growth is likely to
be weak until households are comfortable that
they are more financially secure. It would be a
mistake to think of recovery from such episodes
as a process in which an economy simply reverts
to its previous state.
Second, expenditures with long planning
horizons—notably real estate and capital invest-

the output loss in the ensuing recession is positive, but

financial crises do not stand out.


ment—suffer particularly from the after-effects

of financial crises. This appears to be strongly
associated with weak credit growth. The nature
of these financial crises and the lack of credit
growth during recovery indicate that this is a
supply issue. Further, as elaborated in Box 3.2,
industries that conventionally rely heavily on
external credit recover much more slowly after
these recessions. Figure 3.7. Household Saving Rate and Net Lending
Third, given the below-average trajectory of before and after Business Cycle Peaks
private demand, an important issue is how much (Peak in output at t = 0)
public and external demand can contribute
to growth. In many of the recoveries following In episodes of financial crisis, households dissave during expansions and restore
balance sheets during recessions.
financial crises examined in this section, an
important condition was robust world growth. Household Saving Rate
This raises the question of what happens when (median year-over-year difference; percentage points) 6

world growth is weak or nonexistent. “Big Five” financial crises

Financial crises 4
All other recessions
Are Highly Synchronized Recessions and Their
Recoveries Different? 0

The current downturn is global, implying that

the recovery cannot in the aggregate be driven
by a turnaround in net exports (although this -4
-8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3 4
could be true for individual economies). An Quarters
examination of the features of synchronized
recessions may therefore help in gauging the Change in Household Net Lending in Selected Financial Crisis Episodes
(percent of gross disposable income; positive denotes increase in saving)
evolution of the current recession and prospec- 12
tive recovery. Finland
To address this issue, highly synchronized Norway
United Kingdom
recessions are defined as those during which 10 4
or more of the 21 advanced economies in the
sample were in recession at the same time.25 In
addition to the current cycle, there were three -4
other episodes of highly synchronized reces-
sions: 1975, 1980, and 1992 (Figure 3.9).26 As -8
-2 -1 0 1
seen in Table 3.1, highly synchronized reces- Years

sions are longer and deeper than others: the

Source: IMF staff calculations.
average duration (amplitude) of a synchronous

25Alternatively, synchronized recessions could be

defined as recession events whose peaks coincide within a

given time window, say a year. The results reported in the
text are robust to this definition.
26Note that current recessions are excluded from this

analysis. Almost one-third of all recessions were highly



Figure 3.8. Recessions and Recoveries Associated with Financial Crises and Other
(Median = 100 at t = 0; peak in output at t = 0; data in real terms unless otherwise noted; quarters on the x-axis)

Recessions associated with financial crises are longer and more severe than other recessions. During recoveries, private demand,
credit growth, and asset prices are particularly weak. Historically, net exports have led the recovery.

Financial crises All other recessions

Mean time to trough in output Mean time to trough in output
for financial crises for all other recessions

106 Output Private Consumption 108 Residential Investment 110

104 106
103 100
100 90
99 100
97 98 80
0 2 4 6 8 10 12 0 2 4 6 8 10 12 0 2 4 6 8 10 12

105 Private Capital Investment Credit 112 House Prices 105

100 108 100

95 95

90 102 90
85 98 85
0 2 4 6 8 10 12 0 2 4 6 8 10 12 0 2 4 6 8 10 12

4 Trade Balance1 Unemployment Rate1 3 Nominal Interest Rates 1 1

(share of GDP)
3 0
2 -1
1 -2
0 -3

-1 -1 -4
0 2 4 6 8 10 12 0 2 4 6 8 10 12 0 2 4 6 8 10 12

Source: IMF staff calculations.

1 Difference from level at t = 0, in percentage points.

recession is 40 (45) percent greater than that of than after other recessions. Credit growth is also
other recessions. weak, in contrast to recoveries from nonsyn-
What are the distinctive features of highly syn- chronous recessions, during which credit and
chronized recessions? The most obvious is that investment recover rapidly. As with financial
they are severe, as seen in Figure 3.10. Moreover, crises, investment and asset prices continue to
recoveries from synchronous recessions are, on decline after the trough in GDP. However, a key
average, very slow, with output taking 50 percent difference from the recoveries following local-
longer on average to recover its previous peak ized financial crises is that net trade is much


weaker. When compared with nonsynchronous

recessions, exports are typically more sluggish in
synchronous recessions.
The United States has often been at the
center of synchronous recessions. Three of the
four synchronous recessions (including the
current cycle) were preceded by, or coincided
with, a recession in the United States. During
both the 1975 and 1980 recessions, sharp falls
in U.S. imports caused a significant contraction
in world trade.27 In addition to strong trade
linkages, downward movements in U.S. credit
and equity prices are likely to be transmitted to
Figure 3.9. Highly Synchronized Recessions
other economies.
(Percent of countries in recession; shaded areas denote U.S. recession)

Highly synchronized recessions are rare events that typically are preceded by or
Does Bad Plus Bad Equal Worse? coincide with a U.S. recession.

Recessions that are associated with both

financial crises and global downturns have been
unusually severe and long-lasting. Since 1960,
there have been only 6 recessions out of the 122
in the sample that fit this description: Finland
(1990), France (1992), Germany (1980), Greece
(1992), Italy (1992), and Sweden (1990). On
Ten 40
average, these recessions lasted almost two years
(Table 3.1, final row). Moreover, during these recessions
recessions GDP fell by more than 4¾ percent.
Reflecting in part the severity of these reces-
sions, recoveries from synchronized recessions
are weak.

Can Policies Play a Useful 1960 70 80 90 2000 08:


Countercyclical Role? Q4

Up to this point, this chapter has examined Source: IMF staff calculations.

the dynamics of recessions and recoveries, with-

out accounting for economic policy responses.
Policymakers, however, generally try to reduce
fluctuations in output. Narrative studies of the
policy decision-making process, such as Romer

27In these two recessions, U.S. imports fell by 11 per-

cent and 14 percent, respectively. In the other five U.S.

recessions, imports contracted by 3 percent, on average.
These cases are picked up as recessions associated with
external demand shocks for some countries, but not all,
owing to the threshold that the identification imposes
(see the appendix).


Figure 3.10. Are Highly Synchronized Recessions Different?

(Median = 100 at t = 0; peak in output at t = 0; data in real terms unless otherwise noted; quarters on the x-axis)

Highly synchronized recessions are more protracted and severe than other recessions. Recoveries from these recessions are
typically weak.

Highly synchronized recessions All other recessions

Mean time to trough in output for Mean time to trough in output
highly synchronized recessions for all other recessions

106 Output Private Consumption 107 Residential Investment 105

104 105
104 100
102 103
100 101
98 99 90
0 2 4 6 8 10 12 0 2 4 6 8 10 12 0 2 4 6 8 10 12

108 Private Capital Investment Credit 114 House Prices 102

104 100
108 98
106 96
96 104
92 92
88 98 90
0 2 4 6 8 10 12 0 2 4 6 8 10 12 0 2 4 6 8 10 12

116 Exports Unemployment Rate1 3 Nominal Interest Rates 1 1


96 0 -3
0 2 4 6 8 10 12 0 2 4 6 8 10 12 0 2 4 6 8 10 12

Source: IMF staff calculations.

1 Difference from level at t = 0, in percentage points.

and Romer (1989, 2007), show that concerns in the academic literature. Much of the debate
about the state of the economy are a key input centers on the impact of active, or discretionary,
to the formulation of policy. policies rather than the component of policies
This section examines how monetary and that automatically responds to the business
fiscal policies have been used as a countercycli- cycle. The debate over the role of fiscal policy
cal tool during business cycle downturns. The has been particularly intense, and estimates of
effectiveness of policy interventions in smooth- how output responds to discretionary changes
ing the business cycle is a topic of long debate in policy vary dramatically depending on the


Box 3.2. Is Credit a Vital Ingredient for Recovery? Evidence from Industry-Level Data

One of the most striking features of recoveries

from recessions associated with financial crises is The Behavior of Credit during Recoveries from
the “creditless” nature of these recoveries (first Recessions Associated with Financial Crises
(Median = 100 at t = 0; trough in output at t = 0;
figure). Credit growth typically turns positive only
quarters on the x-axis)
seven quarters after the resumption of output
growth. Although the demand for credit is gener-
ally lower in the aftermath of a financial crisis
as households and firms deleverage, the stress
experienced by the banking sector during these
episodes suggests that restrictions in the supply Output
of credit are also important. This raises an impor-
tant question, which is addressed in this box: To
what extent do restrictions in the supply of credit
constrain the strength of economic recovery? In 102
the absence of financial friction, firms should be
able to costlessly compensate for the decrease in 101
bank credit with other forms of credit, such as
the issuance of debt, leaving their investment and 100
output decisions unchanged. The presence of
market imperfections, however, implies that these 99
different forms of credit are not perfect substi-
tutes, and the result is a slower recovery for firms
and industries that are more reliant on credit.1 0 1 2 3 4 5 6 7 8

Methodology Source: IMF staff calculations.

To examine the impact of credit on the

strength of recovery, this box uses annual pro-
duction data from manufacturing industries in (1998). The differential performance of growth
advanced economies during 1970–2004.2 Reces- in value-added output during recoveries across
sions associated with financial crises are identi- these industries within a particular country
fied in the same way as in the chapter, which is the main channel through which the real
is through the interaction of crises identified impact of credit is identified.
by Reinhart and Rogoff (2008a, 2008b) with The focus on the variation in growth during
business cycle peaks and troughs. Industries are recoveries from recessions associated with finan-
ranked according to the degree to which they cial crises across different industries leads to the
typically finance their activities with outside following empirical specification:3
funds (as opposed to retained earnings) using Growthi,c,t = α1Sizei,c,t–1 + α2(Recoveryc,t
a measure introduced by Rajan and Zingales × Dependencei) + ∑βi,c × di,c

+ ∑γi,t × di,t + ∑δc,t × dc,t + εi,c,t ,

The main author of this box is Prakash Kannan. i,t c,t
1See Bernanke (1983) and Bernanke and Gertler

(1989) for more detailed discussions on the role of

where the subscripts i, c, and t represent obser-
market imperfections in credit markets. vations for a particular industry, country, and
2Data for value added at the three-digit industry time period, respectively.
level are obtained from the IndStat database produced
by the United Nations Industrial Development Orga-
nization. The data cover the 21 advanced economies 3This specification closely follows that of

studied in this chapter. Dell’Ariccia, Detragiache, and Rajan (2008).


Box 3.2. (concluded)

country characteristics, global industry shocks,

Impact of External Funding Dependency on the and country-specific regulations that vary by
Strength of Recovery across Industries1 industry. Finally, growth effects that are related to
the size of the industry as a result of convergence
effects, among other things, are accounted for by
including the lagged share of value-added output
of a particular industry (Sizei,c,t -1).

Growth and Credit during Recoveries

The results based on the empirical specifi-
cation above provide evidence that firms in
industries that depend more on outside funding
-2 do indeed grow more slowly after the end of a
recession associated with a financial crisis (see
table, first column). This suggests that disrup-
tions to the availability of credit have significant
real effects. The estimates presented in the table
suggest that a typical firm in an industry that has
a high dependence on outside funds grows about
1.5 percentage points more slowly than one that
All industries Industries with Industries with relies more on internal funds (second figure).4
low asset low product
tangibility tradability Are there any mitigating factors that could
potentially offset the harmful effects of a
Source: IMF staff calculations. slowdown in the supply of credit? As noted in
1Difference between growth rates of industries with “high” and
the chapter, one key factor that helped econo-
“low” dependency on external funding, where “high” and “low”
dependency refer to the 85th and 15th percentile industry, mies recover from a recession associated with a
financial crisis was the fact that they were able
to benefit from strong external demand. This
The coefficient on the interaction between suggests that disruptions to the supply of credit
an indicator variable for recovery (Recoveryc,t) may not matter much for firms that are highly
and the measure of dependence on outside dependent on outside funding if they produce
funding (Dependencei), α2, captures the extent goods that are highly tradable.
to which credit conditions during recovery To investigate this hypothesis, industries are
affect economic growth. If α2 < 0, industries sorted into those that produce goods that are
that rely more on outside funding, including highly tradable (those above the median value
bank credit, feature lower value-added growth of the fraction of an industry’s output that is
relative to other industries during recoveries, exported or imported) and those that produce
suggesting that restrictions in the supply of credit goods that are less tradable.5 The empirical
have a significant impact on the strength of the specification used above is also used on these
recovery. The growth rate of value added for two subsamples. The results from this exercise
an industry (Growthi,c,t), however, also depends
on a variety of other factors. To capture these 4“High” and “low” refer to the 85th and 15th

broadly, the specification includes three sets of percentile industry, respectively, in the distribution of
dummy variables that control for country-indus- dependency on outside funds.
5The degree of tradability is obtained from mea-
try, industry-time, and country-time fixed effects.
surements by Braun and Larrain (2005), who utilize
This combination of dummy variables allows us Bureau of Economic Analysis tables to compute the
to account for a broad range of effects, such as proportion of an industry’s product that is exported
the severity of the preceding recession, aggregate or imported.


External Finance Dependency and Recoveries from a Financial Crisis

Asset Tangibility Tradability
All High Low High Low
(1) (2) (3) (4) (5)
Lagged size –2.255*** –2.766*** –1.830*** –2.353*** –2.260***
(0.206) (0.344) (0.241) (0.280) (0.285)
Recovery × external dependency –0.038** –0.028 –0.057** –0.020 –0.085*
(0.018) (0.023) (0.029) (0.017) (0.046)
N 15,204 8,071 7,133 8,192 7,012
R2 0.35 0.38 0.37 0.47 0.31
Note: Dependent variable is growth in value added. Robust standard errors are reported in parentheses. ***, **, and * refer to
significance at the 1, 10, and 5 percent level, respectively. “Lagged size” refers to the share of value added of industry i in period t–1.
“Recovery” is an indicator variable that takes on a value of 1 for the first two years following the trough of a recession associated with
financial crisis. All specifications above include country-industry, country-time, and industry-time fixed effects.

confirm the importance of external trade as a bility are not significantly affected by the extent
mitigating factor during recovery from reces- of their dependency on outside funding (see
sions associated with a financial crisis (see table, fourth column). However, as anticipated,
table, second and third columns). For firms in firms in industries that have relatively fewer
industries that produce goods with low trad- tangible assets and that rely more on outside
ability, growth in value added is significantly funding grow much more slowly in the recovery
affected by the extent of their dependency from a financial crisis (see table, fifth column)
on outside funds. For these firms, the differ- These findings suggest that the availability of
ence in the growth rates between those with credit plays an important role in recovery from
high dependency on outside funds and those recessions associated with financial crises, espe-
with low dependency is around 3.3 percentage cially for industries that produce goods that are
points—more than twice the difference in the relatively less tradable and whose assets are less
full sample. For firms in industries that produce tangible. Apart from industries that fall into the
highly tradable goods, the degree of depen- “other manufactured products” classification, the
dency on outside funding does not matter. professional and scientific equipment and machin-
Do other industry characteristics, such as asset ery industries appear to be particularly vulnerable,
tangibility, help offset the effects of tight credit as they exemplify industries that rely heavily on
on growth? In principle, industries that have a outside funding, whose goods are traded relatively
higher proportion of tangible assets should be less, and whose assets are less tangible.7 The find-
better able to obtain outside funding, since these ings are also a reminder of the importance of poli-
assets can be pledged as collateral, thus reduc- cies aimed at restoring the health of the banking
ing spreads charged to the firm. To address this system and financial markets so that the flow of
question, industries are once again sorted into credit can be resumed quickly. This message takes
two groups—those with a high degree of tangi- on additional weight during episodes of financial
bility (above the median level of our measure crisis characterized by a high degree of synchro-
of tangibility) and those with low tangibility.6 nization, because there is no room for external
An interesting result emerges: growth in value- demand to support recovery as it has in the past.
added output during recoveries for firms in
industries that have a high degree of asset tangi-
7Although all the industries covered in the study
6Braunand Larrain (2005) have assembled a mea- fall within the manufacturing sector and, therefore,
sure of asset tangibility by looking at the average ratio produce goods that are largely tradable, the measure
of plant and production equipment to total assets in a of interest here is the relative degree of tradability
given industry. within the sector.


methodology employed, the sample of coun- Discretionary fiscal and monetary policies
tries, and the time period examined. Indeed, have typically been expansionary during reces-
there is evidence that the multipliers can at sions (Figure 3.11).31 The mean increase in the
times be negative. The consensus, however, is discretionary component of government con-
that discretionary fiscal policy does have a posi- sumption during a recession is about 1.1 percent
tive impact on growth, though the magnitude is a quarter, while the average decline in real inter-
fairly small.28 est rates, beyond that implied by a Taylor rule,
A common challenge faced in empirical is about 0.2 percentage point a quarter. 32 The
research on macroeconomic policies is the G7 economies have historically responded more
appropriate measurement of discretionary pol- aggressively with regard to monetary policy than
icy. In general, any measure of macroeconomic other countries.33 Some European economies,
policy is interrelated with output, making causal on the other hand, have been unable to lower
inference difficult. To address this problem, this interest rates independently during recessions,
section distinguishes the automatic response of because of their commitment to the European
policy (which depends on economic activity) exchange rate mechanism and membership in
from the discretionary one by using a simple the euro area.
regression framework. The discretionary compo-
nent of fiscal policy is proxied by the cyclically
adjusted primary fiscal balance as well as by Do Policies Help Mitigate the Duration of
cyclically adjusted real government consump- Recessions?
tion.29 Similarly, the discretionary component The impact of discretionary monetary and
of monetary policy is proxied by the nominal fiscal policies on the duration of recessions
interest rate and real interest rate deviations is examined by looking at the cross-country
from a Taylor rule, which attempts to capture experience across various recession episodes
how the central bank responds to fluctuations in using duration analysis. Duration analysis seeks
the output gap and deviations from an explicit, to model the probability that an event will occur,
or implicit, inflation target. For each recession such as the end of a recession. Previous studies
phase, the baseline measure of policy response have used these models to address the question
is the peak-to-trough change, a cumulative mea- of whether recessions are more likely or less
sure of the degree of loosening or tightening of
policy over the whole recession.30
policy stimulus as the sum of the deviations in each quar-
28See chapter 5 of the October 2008 World Economic ter that the economy is in recession. Most empirical stud-
Outlook for a summary. See also Blanchard and Perotti ies, including those cited previously, do not discriminate
(2002), Ramey (2008), and Romer and Romer (2007) for among the various phases of the business cycle. Excep-
recent attempts at identifying the impact of discretionary tions include Peersman and Smets (2001) and Tagkalakis
fiscal policy. (2008), who show respectively that monetary policy and
29To check for the robustness of these results, an fiscal policy tend to have larger effects during recessions
alternative measure of fiscal policy is also used. This mea- than during expansions.
sure—the percentage change in non-cyclically-adjusted 31Lane (2003) finds that current government spend-

real government consumption—is based on the premise ing, excluding interest payments, is countercyclical for a
that changes in real government expenditures are largely sample of Organization for Economic Cooperation and
independent of the cyclical fluctuations in output. As dis- Development (OECD) countries, though he claims that
cussed in the appendix, most of the results are preserved. automatic stabilizers are the main driving force behind
Public investment spending would have been another the countercyclicality.
option. However, its size is much smaller than that of gov- 32Note that these figures show our measures of the

ernment consumption, and its association with economic discretionary component of policy. Direct measures of
recovery is often limited, owing to significant implemen- policy, such as changes in interest rates or the primary
tation lags (see Spilimbergo and others, 2008). balance, show more marked reductions during recessions.
30Details are presented in the appendix to this chapter. 33 The G7 comprises Canada, France, Germany, Italy,

For the measures of monetary policy, we compute the Japan, United Kingdom, and United States.


likely to end as they grow older.34 The chapter

adds to this analysis by looking at the impact of
policies on the likelihood that an economy exits
a recession.
Across all types of recessions, there is evidence
that expansionary monetary policy is typically
associated with shorter recessions, whereas
expansionary fiscal policy is not. A 1 percent
reduction in the real interest rate beyond that
implied by the Taylor rule increases the prob-
ability of exiting a recession in a given quarter
by about 6 percent. On the other hand, fiscal
policy, measured either by changes in the pri- Figure 3.11. Average Policy Response during a
mary balance or in government consumption, Recession
is not found to have a significant impact on the (Real rate in percentage points; government consumption in percent)
duration of recessions when examined across all
recessions. Discretionary monetary and fiscal policies are typically expansionary during
However, during recessions associated with
financial crises, both expansionary fiscal and All G71
monetary policies tend to shorten the duration
of recessions, although the effect of monetary
policy is not statistically significant (Table 3.3). 1.5
During these episodes, a 1 percent increase in
government consumption is associated with an 1.0
increase in the probability of exiting a reces-
sion of about 16 percent. The stronger impact 0.5

of fiscal policy in these events is consistent with

evidence that fiscal policy is more effective when
economic agents face tighter liquidity con-
straints.35 The lack of a statistically significant
effect from monetary policy could be a result -1.0
Real rate Government consumption
of the stress experienced by the financial sec-
tor during financial crises, which hampers the
Source: IMF staff calculations.
effectiveness of the interest-rate and bank-lend- 1G7 includes Canada, France, Germany, Italy, Japan, United Kingdom, and United
ing channels of the transmission mechanism of States.

monetary policy.36
A useful way of visualizing the impact of mon-
etary and fiscal policies on the duration of reces-

34Previous studies find that postwar recessions in the

United States are more likely to end the longer they prog-
ress (see Diebold and Rudebusch, 1990; and Diebold,
Rudebusch, and Sichel, 1993).
35See Tagkalakis (2008). Bernanke and Gertler (1989)

suggest that liquidity constraints are more prevalent in

recessions than expansions.
36See Bernanke and Gertler (1995) for a detailed dis-

cussion on the credit channel of the monetary transmis-

sion mechanism.


sions is to look at estimates of the probability

that an economy will stay in a recession beyond
a certain number of quarters (Figure 3.12,
upper panel). The estimated probabilities are
significantly higher for recessions associated with
financial crises relative to the average recession,
Figure 3.12. Impact of Policies during Financial Crisis indicating that the former type lasts longer than
Episodes1 the latter. The implementation of expansion-
ary policies clearly helps reduce the median
Recessions associated with financial crises tend to be more protracted. The duration duration of the recession (Figure 3.12, lower
of these recessions, however, can be mitigated by expansionary fiscal and monetary panel). For instance, a one-standard-deviation
increase in government consumption reduces
Survivor Functions for Advanced Economies’ Recessions2
the median duration of a recession associated
1.0 with a financial crisis from 5.1 quarters to 4.1
Financial crisis episodes
quarters. In contrast, the effect of monetary
policy, while still helping to reduce the duration
Full sample Financial crisis episodes 0.6 of a recession associated with financial crisis, is
with high fiscal response 3 insignificant.
Financial crisis
episodes with high
monetary response3 Do Policies Help Boost Recoveries?
0.0 As noted in previous sections, recessions are
0 1 2 3 4 5 6 7 8 9 10
Quarters typically followed by a swift recovery. Although
factors such as technological progress and
Estimated Median Duration of Recessions 6 population growth help the economy eventu-
ally recover, as discussed earlier, this section
investigates whether fiscal and monetary policies
4 undertaken during the recession also contrib-
3 ute to the strength of the economic recovery,
using an event study to exploit the cross-country
variation in the data. The variable of interest in
1 this case is the cumulative output growth one
year after the cyclical trough, which is used as
Full sample Financial Financial crisis Financial crisis a proxy for the strength of the recovery. An
crisis episodes with episodes with
episodes high fiscal high monetary economy emerging from recession has typically
response 3 response 3 surpassed its previous peak output by this time.
Source: IMF staff calculations. The measures of policy used are the same as in
1Recessions associated with financial crises, as described in the text.
2 Survivor functions show the probability of remaining in a recession beyond a certain
the duration analysis, which were measured as
number of quarters. cumulative changes during the recession phase.
3 Refers to a one-standard-deviation increase in government consumption or decrease in
real interest rates, respectively.
In addition to the policy variables, both the
duration and amplitude of the preceding reces-
sion are included as controls.
The results suggest that both fiscal and
monetary expansions undertaken during the
recession are associated with stronger recov-
eries (Table 3.4). In particular, increases in
government consumption, and reductions in


both nominal and real interest rates beyond

that implied by the Taylor rule, have a positive
effect on the strength of economic recovery
(Figure 3.13).37 Table 3.4 shows the quantitative
impact of each policy measure separately and
in combination. The coefficient on the govern-
ment consumption variable, which is about 0.2,
implies that a one-standard-deviation increase
in government consumption during a recession
Figure 3.13. Effect of Policy Variables on the Strength of
is associated with an increase in the cumulative Recovery1
growth rate during the recovery phase of about
0.7 percent. The response to a one-standard- After controlling for the amplitude and duration of the preceding recession as well as
deviation reduction in real interest rates, beyond fixed country characteristics, expansionary policies are associated positively with the
strength of recovery.
that implied by the Taylor rule, is about 0.4 per-
cent. Changes in the cyclically adjusted primary Real Interest Rate 15
balance during a recession, on the other hand,

Cumulative growth rate (percent)

are not significantly associated with output 10

growth during recovery.38

The aggressive use of discretionary fiscal
policy raises concern about the sustainability of 0
public finances. For instance, Perotti (1999),
using a sample of 19 OECD countries, finds that -5

a fiscal stimulus reduces private consumption in

periods during which the level of government -10 -8 -6 -4 -2 0 2 4 6 8
Change in real interest rate (percent)
debt is particularly high.39 Do concerns about
fiscal sustainability detract from the effectiveness Government Consumption 15
of fiscal stimulus during recoveries? To address

Cumulative growth rate (percent)

this question, the levels of public debt relative to 10

GDP that were prevalent at the beginning of the

recession are introduced into the benchmark
regression framework interacted with the proxy 0
of fiscal policy. The results, shown in Table 3.4,
suggest that the degree of public indebtedness -5

reduces the effectiveness of fiscal policy.

To show the nature of this relationship more -10 -5 0 5 10 15
Change in government consumption (percent)
clearly, Figure 3.14 plots the marginal relation-

Source: IMF staff calculations.

37This 1 Scatter plots shown here are conditional plots that take into account the effect of several
positive impact of policy continues to remain
other controlling variables, as noted in the appendix.
statistically significant even after policies that were under-
taken in the early stages of recovery are included.
38There is no evidence that the impact of policies is

any different in strengthening recoveries from recessions

associated with financial crises as compared with other
39The procyclicality of fiscal policy in emerging econo-

mies is also largely attributable to the fact that constraints

on the financing of government debt are usually tighter
during recessions (see Gavin and Perotti, 1997, for a
discussion on Latin America).


ship between the impact of fiscal policy on the

strength of recovery and the debt-to-GDP ratio.
The downward-sloping line indicates that fiscal
stimulus in economies that have low levels of
public debt has a higher impact on the strength
of the recovery relative to economies that have
higher levels of public debt. The point estimate
for the impact becomes negative for debt levels
that exceed about 60 percent of GDP. However,
as suggested by the blue 90 percent confidence
interval bands, there is high uncertainty in the
estimation of the threshold debt levels.40
Figure 3.14. Relationship between the Impact of Fiscal
Policy on the Strength of Recovery and the Debt-to-GDP These findings point to the need for a com-
Ratio mitment to medium-term fiscal sustainability
to accompany any short-term fiscal stimulus.
The impact of fiscal policy on the strength of recovery is weaker for economies that Doubts about debt sustainability can slow the
have higher levels of public debt relative to GDP. recovery process through lower consumer
spending and higher long-term real interest
0.6 rates. It is crucial that the implementation of
temporary stimulus measures occur in a frame-
0.4 work that guarantees fiscal sustainability in order