Mainstream view of world economy

The following Fund Strategy news story by me sums up the current orthodoxy on the global economy.

The world economy is likely to enjoy a gradual recovery in 2009 despite the financial turmoil, according to a senior figure at the International Monetary Fund (IMF).

John Lipsky, the first deputy managing director of the IMF, told a meeting in Washington DC that a severe downturn can be avoided if the policy response is right. “This storm can be weathered without a damaging global recession,” he said. “But attaining such an outcome will require clear and coherent policy responses from public authorities and institutions around the world, together with the restoration of private market functionality and an end to investors’ spiraling crisis of confidence.”

He said the backdrop to the current crisis was that the world economy was becoming “bifurcated” rather than, as many had hoped, decoupled. Both advanced and emerging economies were slowing although they are facing different sorts of problems.
In the developed world the slowdown that started in America has spread to the eurozone and Japan. Such economies seem to be facing a protracted period of slow growth.

Emerging economies are showing resilience but there are signs that capital is starting to flow out of them. Their growth prospects are diminishing and the risk appetite of investors in such countries is declining. As a result the currencies of many emerging countries have weakened.

The outcome of the volatility will depend on the ability of both sets of economies to deal with three simultaneous shocks: rising energy and commodity prices, the housing downturn and the financial turmoil.

Lipsky argued that, despite the scale of these challenges, there are several factors that make a gradual recovery likely. First, oil prices have declined from their summer peak. This should give a particular boost to the American economy.

The IMF says it is also likely that the American housing market will bottom in 2009. Key indicators, such as affordability levels, are improving. In addition, economies are in reasonable shape in many respects. In America, for instance, corporate finances remains relatively healthy. Finally, emerging economy growth remain robust. Such buoyancy should also help American exports.

* “The global economic and financial turmoil: finding our footing”. Available at www.imf.org