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Unit 4 Macro: IMF Flags up Risks of Double Dip

Tuesday, September 20, 2011
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Here are some of the salient points from the gloomy World Economic Forecast from the IMF which argues that the global economy has entered a dangerous phase.

The IMF report highlights many of the vulnerabilities facing both developed and emerging economies. In Britain the media is emphasising a sizeable reduction in the forecast rate of growth for the UK for 2011 and 2012. Real GDP in the UK is likely to expand by just 1.1% in 2011 and 1.6% next year and the IMF economists say that there is a one in five chance of a double dip recession.

Weak growth is terrible news for the Chancellor who is hoping for a significant expansion of the private sector to offset fiscal cuts and to meet the targets for fiscal deficit reduction. It is also awful for prospects of a meaningful reduction in unemployment and prospects of tackling the structural issue of very high youth unemployment rates.

Incidentally that risk of a double-dip is thought to be much higher in the United States where the probability of a second recession following a partial recovery is put at 40%.

World Economic Outlook - IMF - September 2011 - Slowing Growth, Rising Risks

1/ The world economy suffers from a much slower recovery in advanced economies since the beginning of the year and large increase in fiscal and financial uncertainty. Although the recession has ended, many economies continue to operate far below pre-crisis trends (i.e. there are large output gaps and persistently high unemployment rates). Is the new normal average growth rate for Euro Area, the USA and UK likely to be weaker than in the last fifteen years?

2/ What is needed is a shift from fiscal stimulus to private demand BUT a squeeze on bank lending, the legacy of the housing boom, and high debts for many households all turn out to be putting stronger brakes on the recovery than the IMF anticipated

3/ Financial markets have become more skeptical about the ability of many countries to stabilize their public debt. Weak GDP growth makes it more difficult for government to achieve debt sustainability and leads markets to worry even more about fiscal stability. For the UK, the IMF’s latest estimate of the structural budget deficit in 2011-2012 is £94bn - that is £12bn more than published by the Office of Budgetary responsibility back in August 2011.

4/ Fiscal consolidation (i.e. spending cuts, tax rises - deficit reduction) cannot be too fast or it will kill growth. It cannot be too slow or it will kill credibility. This is a crucial dilemma facing many governments.

5/ The world economy needs to re-balance. Exports from the United States and crisis-hit economies must increase, and, by implication, net exports from the rest of the world including emerging market countries running sizeable current account surpluses must decrease. Further pressure here from the IMF on emerging countries to allow their exchange rates to appreciate.

6/ Persistently high unemployment threatens a long-term decline in productive capacity and competitiveness. High unemployment (with more than 40 percent of the unemployed out of work for
six months or more) may result in a permanent loss of work skills (a clear reference here to the risk of hysteresis effects)

7/ Inflation is higher in many countries than might have been expected at the end of a deep recession. Rising food and commodity prices have exacerbated social problems posed by underemployment or high unemployment, especially among the young in both advanced and emerging economies.

Growth Forecasts for 2011

% change in real GDP

World Output: 4.0%
United States: 1.5%
Euro Area: 1.6%
Greece: -5.2%
Portugal: -2.,2%
United Kingdom: 1.1%
Newly Industrialized Asian Economies: 4.7%
China: 9.5%
India: 7.8%

Risks to growth

The IMF picks out four key external risks and uncertainties facing many countries

(1) weak sovereigns (governments) and banks in a number of advanced economies - there are dangers of a fresh a liquidity shock (credit crunch 2.1?) as global investors take flight into precious metals and cash

(2) insufficiently strong policies to address the legacy of the crisis in the major advanced economies

(3) vulnerabilities in a number of emerging market economies - including rising inflation and fears of over-heating

(4) volatile commodity prices and geopolitical tensions

Media coverage of the IMF forecast:

BBC News (video): UK economy enters dangerous phase
Independent: IMF cuts growth forecasts for UK
Guardian: US and Europe risk double-dip recession, warns IMF

 


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AS & A2 Economics Revision Workshops

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AS & A2 Economics - Macroeconomics: National & International Economy (Unit 2),  Global/International Economy (Unit 4)

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