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Print Edition> Business
UPDATED: October 18, 2010 NO. 42 OCTOBER 21, 2010
Crisis Focus: What's Next for the World Economy?

The global economic recovery is proceeding with gains being made across the board, but risks remain, causing a high level of skepticism to linger. Most advanced economies and a few emerging economies still face large adjustments, but on the whole, developing countries are faring much better than their developed counterparts. The IMF released its biannual World Economic Outlook in October 2010, which set out to find ongoing problems and suggest a number of solutions for countries the world over. Edited excerpts follow:

The economic recovery continued to gain momentum in the first half of 2010. A surge in inventory and, lately, fixed investment contributed to the dramatic rise in manufacturing and global trade. But low consumer confidence and declining household incomes are holding consumption down in many advanced economies. Their recoveries will remain fragile until business investment improves, allowing employment numbers to rise. However, household spending is doing well in many emerging market economies, which expanded almost 8 percent and where investment is propelling job creation.

At the same time, financial stability suffered a major setback: Market volatility increased and investor confidence dropped. Prices in many stock exchanges fell, led initially by financial stocks and by European markets. Heavy sovereign debt sales among vulnerable eurozone economies rattled the banking system, triggering a systemic crisis. This added to existing worries about the sustainability of the recovery and caused a broader decline in stocks. Since the beginning of the summer, however, financial conditions have improved again. Tail risks have been reduced by unprecedented European policy initiatives and by a front-loading of fiscal adjustment. However, underlying sovereign and banking vulnerabilities remain a significant challenge amid lingering concerns about risks to the global recovery.

Future policies need to be more proactive to achieve the required internal-external rebalancing. Most advanced economies and a few emerging economies still face major adjustments, including the need to strengthen household balance sheets, stabilize and subsequently reduce high public debt, and repair and reform their financial sectors. Monetary policies should remain supportive in most advanced economies and should be the first line of defense against any larger-than-projected weakening of activity as fiscal support diminishes. With policy rates already near zero in larger advanced economies, monetary policymakers may have to resort to further unconventional measures if private demand weakens unexpectedly as fiscal support wanes.

One of the most urgent challenges for advanced economies is to legislate plans that help achieve sustainable fiscal positions before the end of the decade. This task is now more pressing than it was six months ago to make room for fiscal policy to maneuver in the face of still-volatile sovereign debt markets. The introduction of credible, growth-friendly, medium-term fiscal consolidation plans would help limit the deflationary impact of consolidation on private demand in the short term.

Emerging economies will have to rebalance growth further toward domestic sources to achieve growth rates similar to those before the crisis, helping the required external rebalancing. In economies with excessive external surpluses, which are mainly in emerging Asia, fiscal tightening should therefore take a backseat to monetary tightening and exchange rate flexibility. In many other emerging economies, fiscal tightening can start immediately, because domestic demand recovery is already well underway or public debt is relatively high.

To sustain or further raise potential growth and employment, efforts could usefully focus on simplifying product and services market regulation, raising human capital, and building critical infrastructure.

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