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Print Edition> Business
UPDATED: April 30, 2010 NO. 18 MAY 6, 2010
Crisis Focus: Prescribing Economic Remedies

After slowly emerging from the financial crisis, the world economy has left the worst behind it. But the road ahead will by no means be a smooth one. Staggering unemployment, sovereign debt crises and inflationary jitters continue to stretch the nerves of policymakers. In the World Economic Outlook, an assessment of the global economy, the International Monetary Fund discussed these issues and their impact on the global economic recovery. Edited excerpts follow:

The global recovery is proceeding at varying speeds—tepidly in many advanced economies and solidly in most emerging markets. World growth is now expected to be 4.25 percent in 2010.

As the recovery has gained traction, risks to global financial stability have eased, but stability itself has not yet been assured. In banking systems, there still remain pockets that are characterized by shortages of capital, high risks of further asset deterioration and chronically weak profitability.

The outlook for economic activities remains unusually uncertain, and downside risks stemming from fiscal weaknesses have come to the forefront. A key concern is that room for policy maneuvers in many developed economies has either been exhausted or become much too limited. Moreover, sovereign risks could undermine their financial stability gains and extend the crisis. The rapid increase in public debt and deterioration of fiscal balance sheets could be transmitted back to banking systems or across borders. This underscores the need for policy action to sustain the recovery of the global economy and financial system.

The policy agenda should include several important elements. The key task ahead is to reduce sovereign vulnerabilities. In many advanced economies, there is a pressing need to design and communicate credible medium-term fiscal consolidation strategies. These should include clear time frames to bring down gross debt-to-GDP ratios over the medium term as well as contingency measures if the deterioration in public finances is greater than expected.

At the same time, better growth prospects in many emerging economies and low interest rates in major economies have triggered a welcome resurgence of capital flows. These capital flows, however, come with the risk of inflation pressure and asset bubbles. Major emerging and some advanced economies will continue to lead the tightening cycle, since they are experiencing faster recoveries and renewed capital flows. Although there is only limited evidence of inflation pressures and asset price bubbles, current conditions warrant close scrutiny and early action.

Combating unemployment is yet another policy challenge. Beyond pursuing macroeconomic policies that support recovery in the near future and financial sector policies that restore the banking sector's health, specific labor market policies could also help limit damage to the labor market. In particular, adequate unemployment benefits are essential to support confidence among households and to avoid large increases in poverty, and education and training can help reintegrate the unemployed into the labor force.

Finally, the world's ability to sustain high growth over the medium term depends on rebalancing global demand. This means economies that had excessive external deficits before the crisis need to consolidate their public finances in ways that limit damage to growth and demand. Concurrently, economies that ran excessive current account surpluses will need to further increase domestic demand to sustain growth, as deficit economies scale back their demand. Rebalancing also needs to be supported with financial sector reform and growth-enhancing structural policies in both surplus and deficit economies.

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