WORLD ECONOMIC OUTLOOK

World Economic and Financial Surveys WORLD ECONOMIC OUTLOOK April 2011 Tensions from the Two-Speed Recovery Unemployment, Commodities, and Capital Flows International Monetary Fund

©2011 International Monetary Fund Production: IMF Multimedia Services Division Cover and Design: Luisa Menjivar and Jorge Salazar Composition: Maryland Composition Cataloging-in-Publication DataWorld economic outlook (International Monetary Fund) World economic outlook : a survey by the staff of the International Monetary Fund. —Washington, DC : International Monetary Fund, 1980– v. ; 28 cm. — (1981–1984: Occasional paper / International Monetary Fund, 0251-6365).— (1986– : World economic and financial surveys, 0256-6877)Semiannual. Some issues also have thematic titles.Has occasional updates, 1984– 1. Economic development — Periodicals. 2. Economic forecasting — Periodicals.3. Economic policy — Periodicals. 4. International economic relations — Periodicals.I. International Monetary Fund. II. Series: Occasional paper (International Monetary Fund).III. Series: World economic and financial surveys.HC10.80ISBN 978-1-61635-059-8 Please send orders to: International Monetary Fund, Publication Services P.O. Box 92780, Washington, D.C. 20090, U.S.A. Tel.: (202) 623-7430 Fax: (202) 623-7201 E-mail: publications@imf.org www.imfbookstore.org

CONTENTSAssumptions and Conventions ixPreface xiForeword xiiiExecutive Summary xvChapter 1. Global Prospects and Policies 1 The Recovery Has Solidified, but Unemployment Remains High 1 Financial Conditions Are Improving 1 Commodity Prices Are Resurgent 5 The Recovery Is Expected to Solidify 7 Risks Are Smaller but Remain to the Downside 10 Differences in the Pace of Activity Present Short-Term Policy Challenges 13 Advanced Economies Need to Repair Public and Financial Balance Sheets 14 Emerging Market Economies Need to Guard against Overheating and Credit Booms 18 Global Demand Rebalancing Is Not Progressing 23 Unemployment Needs to Be Reduced 26 Policies Are Not Yet Sufficiently Proactive 27 Appendix 1.1. Financial Conditions Indices 28 Appendix 1.2. Commodity Market Developments and Prospects 30 References 56Chapter 2. Country and Regional Perspectives 59 Recovery Proceeds in the United States 60 A Gradual and Uneven Recovery Is under Way in Europe 64 A Moderate Recovery Continues in the Commonwealth of Independent States 69 Rapid Growth Continues in Asia 72 Latin America Faces Buoyant External Conditions 76 Growth Has Returned to Precrisis Rates in Many African Countries 79 The Recovery in the Middle East and North Africa Region Faces an Uncertain Environment 82 References 88Chapter 3. Oil Scarcity, Growth, and Global Imbalances 89 What Are the Main Findings? 90 Has Oil Become a Scarce Resource? 90 Oil Scarcity and the Global Economy 101 Implications for the Outlook and Policies 109 Appendix 3.1. Low-Frequency Filtering for Extracting Business Cycle Trends 112 Appendix 3.2. The Energy and Oil Empirical Models 112 References 123 International Monetary Fund | April 2011 iii

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERY Chapter 4. International Capital Flows: Reliable or Fickle? 125 What Are the Main Findings? 129 Trends in Net Capital Flows: Size, Composition, Volatility, and Persistence 130 Capital Flows and the Global Environment 134 Does Direct Financial Exposure Affect the Response of Private Capital Flows to Changes in U.S. Monetary Policy? 137 Policy Implications and Conclusions 148 Appendix 4.1. Classification of Economies and Data Sources 148 Appendix 4.2. Composition, Volatility, and Persistence of Net Private Capital Flows across Emerging Market Regions 152 Appendix 4.3. Global Factor Model 153 Appendix 4.4. Regression Methodology and Robustness Checks 155 References 161 Annex: IMF Executive Board Discussion of the Outlook, March 2011 165 Statistical Appendix 167 Assumptions 167 What’s New 168 Data and Conventions 168 Classification of Countries 169 General Features and Composition of Groups in the World Economic Outlook Classification 169 Table A. Classification by World Economic Outlook Groups and Their Shares in Aggregate GDP, Exports of Goods and Services, and Population, 2009 171 Table B. Advanced Economies by Subgroup 172 Table C. European Union 172 Table D. Emerging and Developing Economies by Region and Main Source of Export Earnings 173 Table E. Emerging and Developing Economies by Region, Net External Position, and Status as Heavily Indebted Poor Countries 174 Box A1. Economic Policy Assumptions Underlying the Projections for Selected Economies 176 List of Tables 180 Output (Tables A1–A4) 181 Inflation (Tables A5–A7) 189 Financial Policies (Table A8) 195 Foreign Trade (Table A9) 196 Current Account Transactions (Tables A10–A12) 198 Balance of Payments and External Financing (Tables A13–A15) 204 Flow of Funds (Tables A16) 208 Medium-Term Baseline Scenario (Table A17) 212 World Economic Outlook, Selected Topics 213 Boxes Box 1.1. House Price Busts in Advanced Economies: Repercussions for Global Financial Markets 43 Box 1.2. World Economic Outlook Downside Scenarios 47 Box 1.3. International Spillovers and Macroeconomic Policymaking 50 Box 1.4. Did the Plaza Accord Cause Japan’s Lost Decades? 53iv International Monetary Fund | April 2011

CONTENTS Box 2.1. Unwinding External Imbalances in the European Union Periphery 86 Box 3.1. Life Cycle Constraints on Global Oil Production 115 Box 3.2. Unconventional Natural Gas: A Game Changer? 118 Box 3.3. Short-Term Effects of Oil Shocks on Economic Activity 121 Box A1. Economic Policy Assumptions Underlying the Projections for Selected Economies 176Tables Table 1.1. Overview of the World Economic Outlook Projections 2 Table 1.2. Global Oil Demand and Production by Region 33 Table 1.3. Consumption of Base Metals 37 Table 1.4. Annual Price Changes for Key Commodities 42 Table 1.5. Trade Balance Impact of Higher Prices 42 Table 1.1.1. Cross-Country Financial Market Synchronization 45 Table 2.1. Selected Advanced Economies: Real GDP, Consumer Prices, Current Account Balance, and Unemployment 63 Table 2.2. Selected European Economies: Real GDP, Consumer Prices, Current Account Balance, and Unemployment 67 Table 2.3. Commonwealth of Independent States: Real GDP, Consumer Prices, Current Account Balance, and Unemployment 71 Table 2.4. Selected Asian Economies: Real GDP, Consumer Prices, Current Account Balance, and Unemployment 73 Table 2.5. Selected Western Hemisphere Economies: Real GDP, Consumer Prices, Current Account Balance, and Unemployment 78 Table 2.6. Selected Sub-Saharan African Economies: Real GDP, Consumer Prices, Current Account Balance, and Unemployment 81 Table 2.7. Selected Middle East and North African Economies: Real GDP, Consumer Prices, Current Account Balance, and Unemployment 83 Table 3.1. Oil Demand Price and Income Elasticities 97 Table 3.2. Oil Demand Price and Income Elasticities, Including Oil-Exporting Economies 113 Table 3.3. Oil Demand Price and Income Elasticities in the Extended Sample 114 Table 3.4. Oil Demand Price and Income Short-Term Elasticities: High versus Low Oil Price Environments 114 Table 3.2.1. Unconventional Natural Gas Resources, 2009 118 Table 3.2.2. Composition of Wholesale Gas Transactions: United States and Europe, 2007 120 Table 3.3.1. Annualized Percent Impact of a 10 Percent Oil Price Increase on Real U.S. GDP Growth after One Year 122 Table 4.1. Economy Groupings 150 Table 4.2. Data Sources 151 Table 4.3. Baseline Results 157 Table 4.4. U.S. Direct Financial Exposure Weight 158 Table A1. Summary of World Output 181 Table A2. Advanced Economies: Real GDP and Total Domestic Demand 182 Table A3. Advanced Economies: Components of Real GDP 183 Table A4. Emerging and Developing Economies: Real GDP 185 Table A5. Summary of Inflation 189 Table A6. Advanced Economies: Consumer Prices 190 International Monetary Fund | April 2011 v

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERY Table A7. Emerging and Developing Economies: Consumer Prices 191 Table A8. Major Advanced Economies: General Government Fiscal Balances and Debt 195 Table A9. Summary of World Trade Volumes and Prices 196 Table A10. Summary of Balances on Current Account 198 Table A11. Advanced Economies: Balance on Current Account 199 Table A12. Emerging and Developing Economies: Balance on Current Account 200 Table A13. Emerging and Developing Economies: Net Financial Flows 204 Table A14. Emerging and Developing Economies: Private Financial Flows 205 Table A15. Emerging and Developing Economies: Reserves 206 Table A16. Summary of Sources and Uses of World Savings 208 Table A17. Summary of Word Medium-Term Baseline Scenario 212 Online Tables Table B1. Advanced Economies: Unemployment, Employment, and Real per Capita GDP Table B2. Emerging and Developing Economies: Real GDP Table B3. Advanced Economies: Hourly Earnings, Productivity, and Unit Labor Costs in Manufacturing Table B4. Emerging and Developing Economies: Consumer Prices Table B5. Summary of Financial Indicators Table B6. Advanced Economies: General and Central Government Net Lending/Borrowing and Excluding Social Security Schemes Table B7. Advanced Economies: General Government Structural Balances Table B8. Advanced Economies: Exchange Rates Table B9. Emerging and Developing Economies: General Government Net Lending/Borrowing and Overall Fiscal Balance Table B10. Emerging and Developing Economies: Broad Money Aggregates Table B11. Advanced Economies: Export Volumes, Import Volumes, and Terms of Trade in Goods and Services Table B12. Emerging and Developing Economies by Region: Total Trade in Goods Table B13. Emerging and Developing Economies by Source of Export Earnings: Total Trade in Goods Table B14. Advanced Economies: Current Account Transactions Table B15. Emerging and Developing Economies: Balances on Current Account Table B16. Emerging and Developing Economies by Region: Current Account Transactions Table B17. Emerging and Developing Economies by Analytical Criteria: Current Account Transactions Table B18. Summary of Balance of Payments, Financial Flows, and External Financing Table B19. Emerging and Developing Economies by Region: Balance of Payments and External Financing Table B20. Emerging and Developing Economies by Analytical Criteria: Balance of Payments and External Financing Table B21. Summary of External Debt and Debt Service Table B22. Emerging and Developing Economies by Region: External Debt by Maturity and Type of Creditor Table B23. Emerging and Developing Economies by Analytical Criteria: External Debt, by Maturity and Type of Creditor Table B24. Emerging and Developing Economies: Ratio of External Debt to GDPvi International Monetary Fund | April 2011

CONTENTS Table B25. Emerging and Developing Economies: Debt-Service Ratios Table B26. Emerging and Developing Economies, Medium-Term Baseline Scenario: Selected Economic IndicatorsFigures Figure 1.1. Global Indicators 3 Figure 1.2. Recent Financial Market Developments 4 Figure 1.3. Emerging Market Conditions 5 Figure 1.4. Developments in Mature Credit Markets 6 Figure 1.5. Current and Forward-Looking Trade Indicators 7 Figure 1.6. Global Outlook 8 Figure 1.7. Current and Forward-Looking Growth Indicators 9 Figure 1.8. Prospects for Near-Term Activity 10 Figure 1.9. Balance Sheets and Saving Rates 11 Figure 1.10. Global Inflation 12 Figure 1.11. Measures of Monetary Policy and Liquidity in Selected Advanced and Emerging Economes 13 Figure 1.12. General Government Fiscal Balances and Public Debt 14 Figure 1.13. Risks to the Global Outlook 15 Figure 1.14. Emerging Tensions 19 Figure 1.15. Overheating Indicators and Capital Inflows 20 Figure 1.16. Emerging Market Economies with Strong Credit Expansion 21 Figure 1.17. Global Imbalances 23 Figure 1.18. External Developments 24 Figure 1.19. Unemployment 26 Figure 1.20. Financial Conditions Indices 29 Figure 1.21. Commodity Prices 31 Figure 1.22. World Energy Market Developments 34 Figure 1.23. Developments in Base Metal Markets 36 Figure 1.24. Developments in Markets for Major Food Crops 38 Figure 1.25. Changes in International and Domestic Food Prices and Headline Inflation 39 Figure 1.26. First-Round Impact of Commodity Price Changes on the Trade Balances of Selected Emerging and Developing Economies 41 Figure 1.1.1. Financial Disruptions 43 Figure 1.1.2. Effect of Advanced Economy House Price Busts 44 Figure 1.2.1. WEO Downside Scenario 1: Implications of Overestimating Potential Output 48 Figure 1.2.2. WEO Downside Scenario 2: Implications of Overestimating Potential Output with Sticky Inflation 49 Figure 1.3.1. Optimized Exchange Rate Coefficient and Relative Loss as a Function of Home Output Gap Response 51 Figure 1.4.1. Japan: Selected Macroeconomic Indicators 54 Figure 1.4.2. Japan and China: Balance Sheets and Export Content 55 Figure 2.1. Global Average Projected Real GDP Growth during 2011–12 59 Figure 2.2. Output Gaps 60 Figure 2.3. United States and Canada: Average Projected Real GDP Growth during 2011–12 61 Figure 2.4. United States: Gaining Traction 62 Figure 2.5. Europe: Average Projected Real GDP Growth during 2011–12 65 International Monetary Fund | April 2011 vii

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERY Figure 2.6. Europe: A Gradual and Uneven Recovery Continues 66 Figure 2.7. Commonwealth of Independent States: Average Projected Real GDP Growth during 2011–12 69 Figure 2.8. Commonwealth of Independent States: A Moderate Recovery Is under Way 70 Figure 2.9. Asia: Average Projected Real GDP Growth during 2011–12 72 Figure 2.10. Asia: Still in the Lead 74 Figure 2.11. Latin America and the Caribbean: Average Projected Real GDP Growth during 2011–12 76 Figure 2.12. Latin America and the Caribbean: Icarus or Daedalus? 77 Figure 2.13. Sub-Saharan Africa: Average Projected Real GDP Growth during 2011–12 79 Figure 2.14. Sub-Saharan Africa: Back to Precrisis Growth 80 Figure 2.15. Middle East and North Africa: Average Projected Real GDP Growth during 2011–12 82 Figure 2.16. Middle East and North Africa: The Recovery Continues in an Uncertain Environment 84 Figure 2.1.1. Economic Activity and External Adjustment in the EU Periphery 86 Figure 2.1.2. External Adjustment in the EU Periphery 87 Figure 3.1. Energy Prices and Long-Term Price Trends 92 Figure 3.2. Global Energy Demand, 1980–2008 93 Figure 3.3. Relationship between per Capita Energy Consumption and GDP Growth 94 Figure 3.4. Primary Energy Consumption 95 Figure 3.5. Oil Consumption in China and in Selected Advanced Economies 96 Figure 3.6. The Big Switch: Oil Share in the Electric Power Sector 98 Figure 3.7. Global Oil Market Developments 99 Figure 3.8. Projected Growth in Crude Oil Capacity 100 Figure 3.9. Oil Scarcity and the Global Economy: Benchmark Scenario 102 Figure 3.10. Alternative Scenario 1: Greater Substitution away from Oil 105 Figure 3.11. Alternative Scenario 2: Greater Decline in Oil Production 107 Figure 3.12. Alternative Scenario 3: Greater Economic Role for Oil 108 Figure 3.1.1. Life Cycle of Global Oil Production 115 Figure 3.2.1. U.S. Natural Gas Supply, 1998–2009 119 Figure 3.2.2. U.S. Natural Gas versus Oil Spot Prices 120 Figure 4.1. The Collapse and Recovery of Cross-Border Capital Inflows 126 Figure 4.2. The Evolution of Gross and Net Capital Flows 127 Figure 4.3. The Recovery of Net Private Capital Flows 128 Figure 4.4. The Recovery of Net Capital Flows and Their Composition 131 Figure 4.5. The Size and Composition of Net Private Capital Flows during Waves of Large Capital Flows to Emerging Market Economies 132 Figure 4.6. Regional Variation in Net Private Capital Flows to Emerging Market Economies 133 Figure 4.7. The Relative Importance of Various Types of Flow 134 Figure 4.8. Historical Trends: A Shift away from Debt-Creating Flows 135 Figure 4.9. The Volatility of Net Private Capital Flows 136 Figure 4.10. Correlations between Net Flows of Various Types and the Rest of the Financial Account 137 Figure 4.11. The Persistence of Net Private Capital Flows 138 Figure 4.12. Historical Periods of Easy External Financing and High Growth Differential between Emerging Market and Advanced Economies 139viii International Monetary Fund | April 2011

CONTENTSFigure 4.13. Net Private Capital Flows during Periods of Easy External Financing and High Growth Differential between Emerging Market and Advanced Economies 140Figure 4.14. Net Private Flows to Emerging Market Economies under Alternative Financing Conditions 141Figure 4.15. Common Factors Underlying the Variation in Net Private Capital Flows to Advanced and Emerging Market Economies 142Figure 4.16. Difference in the Response of Net Private Capital Flows to U.S. Monetary Tightening across Economies 143Figure 4.17. Difference in the Response of Emerging Market Economy Net Private Capital Flows to U.S. Monetary Tightening by Selected Economic Characteristics 145Figure 4.18. Difference in the Response of Emerging Market Economy Net Private Capital Flows to U.S. Monetary Tightening by Type of Flow 146Figure 4.19. Difference in the Response of Emerging Market Economy Net Private Capital Flows to U.S. Monetary Tightening under Alternative Global Economic Conditions 147Figure 4.20. The Relative Importance of Various Types of Flow across Emerging Market Regions 153Figure 4.21. The Volatility of Net Private Capital Flows across Emerging Market Regions 154Figure 4.22. The Persistence of Net Private Capital Flows across Emerging Market Regions 155Figure 4.23. Realized and Unanticipated Changes in U.S. Monetary Policy over Time 159Figure 4.24. Robustness Checks for the Difference in Response of Net Private Capital Flows to Directly Financially Exposed Emerging Market Economies 160 International Monetary Fund | April 2011 ix

ASSUMPTIONS AND CONVENTIONS 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 remained constant at their average levels during February8–March 8, 2011, except for the currencies participating in the European exchange rate mechanism II (ERMII), which are assumed to have remained constant in nominal terms relative to the euro; that established poli-cies of national authorities will be maintained (for specific assumptions about fiscal and monetary policies forselected economies, see Box A1); that the average price of oil will be $107.16 a barrel in 2011 and $108.00a barrel in 2012 and will remain unchanged in real terms over the medium term; that the six-month Londoninterbank offered rate (LIBOR) on U.S. dollar deposits will average 0.6 percent in 2011 and 0.9 percent in2012; that the three-month euro deposit rate will average 1.7 percent in 2011 and 2.6 percent in 2012; andthat the six-month Japanese yen deposit rate will yield on average 0.6 percent in 2011 and 0.3 percent in2012. These are, of course, working hypotheses rather than forecasts, and the uncertainties surrounding themadd to the margin of error that would in any event be involved in the projections. The estimates and projec-tions are based on statistical information available through late March 2011. 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, 2010–11 or January–June) to indicate the years or months covered, including the beginning and ending years or months; / between years or months (for example, 2010/11) 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 of1 percentage point). WEO aggregated data excludes Libya for projection years due to the uncertain political situation. Except for GDP growth and inflation, projections for Côte d’Ivoire are not shown due to the uncertainpolitical situation. In figures and tables, shaded areas indicate IMF staff projections. If no source is listed on tables and figures, data are drawn from the 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 terms “country” and “economy” do not in all cases refer to a territorial entity thatis a state as understood by international law and practice. As used here, the term also covers some territorialentities that are not states but for which statistical data are maintained on a separate and independent basis. Composite data are provided for various groups of countries organized according to economic characteris-tics or region. Unless otherwise noted, country group composites represent calculations based on 90 percent ormore of the weighted group data. The country group composites for fiscal data are calculated as the sum of the U.S dollar values for therelevant individual countries. This differs from the calculations in the October 2010 and earlier issues of theWorld Economic Outlook, for which the composites were weighted by GDP valued at purchasing power parities(PPPs) as a share of total world GDP. The boundaries, colors, denominations, and any other information shown on the maps do not imply, onthe part of the International Monetary Fund, any judgment on the legal status of any territory or any endorse-ment or acceptance of such boundaries. International Monetary Fund | April 2011 xi

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERY FURTHER INFORMATION AND DATA This version of the World Economic Outlook is available in full on the IMF’s website, www.imf.org. Accom- panying 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, forum, 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. Forum address: www.imf.org/weoforum Fax: (202) 623-6343xii International Monetary Fund | April 2011

PREFACE The analysis and projections contained in the World Economic Outlook are integral elements of the IMF’ssurveillance of economic developments and policies in its member countries, of developments in internationalfinancial markets, and of the global economic system. The survey of prospects and policies is the productof a comprehensive interdepartmental review of world economic developments, which draws primarily oninformation the IMF staff gathers through its consultations with member countries. These consultations arecarried out in particular by the IMF’s area departments—namely, the African Department, Asia and PacificDepartment, European Department, Middle East and Central Asia Department, and Western HemisphereDepartment—together with the Strategy, Policy, and Review Department; the Monetary and Capital MarketsDepartment; and the Fiscal Affairs Department. The analysis in this report was coordinated in the Research Department under the general directionof Olivier Blanchard, Economic Counsellor and Director of Research. The project was directed by JörgDecressin, Senior Advisor, Research Department, and Petya Koeva Brooks, Division Chief, Research Depart-ment. The primary contributors to this report are Abdul Abiad, John Bluedorn, Rupa Duttagupta, JaimeGuajardo, Thomas Helbling, Joong Shik Kang, Michael Kumhof, Dirk Muir, Andrea Pescatori, Shaun Roache,John Simon, and Petia Topalova. Other contributors include Joshua Felman, Benjamin Hunt, FlorenceJaumotte, Mika Kortelainen, Daniel Leigh, Troy Matheson, Stephen Snudden, Marco Terrones, and RobertTetlow. Kevin Clinton provided comments and suggestions. Toh Kuan, Gavin Asdorian, Shan Chen, AngelaEspiritu, Murad Omoev, Andy Salazar, Min Kyu Song, Ercument Tulun, Jessie Yang, Nese Erbil, DavidReichsfeld, and Marina Rousset provided research assistance. Saurabh Gupta, Mahnaz Hemmati, LaurentMeister, Emory Oakes, and Steve Zhang managed the database and the computer systems. Tita Gunio, ShantiKarunaratne, and Cristina Tumale were responsible for word processing. Linda Griffin Kean of the ExternalRelations Department edited the manuscript and coordinated the production of the publication. Addi-tional technical support was provided by external consultants Vladimir Bougay, Anastasia Francis, AleksandrGerasimov, Wendy Mak, Shamiso Mapondera, Nhu Nguyen, and Pavel Pimenov. The analysis has benefited from comments and suggestions by staff from other IMF departments, as well asby Executive Directors following their discussion of the report on March 28, 2011. However, both projectionsand policy considerations are those of the IMF staff and should not be attributed to Executive Directors or totheir national authorities. International Monetary Fund | April 2011 xiii

FOREWORD he world economic recovery continues, to come. The source of low growth can be traced toT more or less as predicted. Indeed, our growth forecasts are nearly unchanged since the January 2011 WEO Updateand can be summarized in three numbers: Weexpect the world economy to grow at about 4½ both precrisis excesses and crisis wounds: In many countries, especially the United States, the housing market is still depressed, leading to anemic housing investment. The crisis itself has led to a dramatic deterioration in fiscal positions, forcing a shift topercent a year in both 2011 and 2012, but with fiscal consolidation while not eliminating marketadvanced economies growing at only 2½ percent worries about fiscal sustainability. And in manywhile emerging and developing economies grow at a countries banks are struggling to achieve highermuch higher 6½ percent. capital ratios in the face of increasing nonperform- Earlier fears of a double-dip recession—which ing loans.we did not share—have not materialized. The main The problems of the European Union periph-worry was that in advanced economies, after an ini- ery, stemming from the combined interactions oftial recovery driven by the inventory cycle and fiscal low growth, fiscal woes, and financial pressures,stimulus, growth would fizzle. The inventory cycle are particularly acute. Reestablishing fiscal andis now largely over and fiscal stimulus has turned to financial sustainability in the face of low or nega-fiscal consolidation, but private demand has, for the tive growth and high interest rates is a substantialmost part, taken the baton. challenge. And, while extreme, the problems of the Fears have turned to commodity prices. Com- EU periphery point to a more general problem: anmodity prices have increased more than expected, underlying low rate of growth of potential output.reflecting a combination of strong demand growth Adjustment is very hard when growth is very low.and supply shocks. Although these increases conjure The policy advice to advanced economies remainsup the specter of 1970s-style stagflation, they largely the same as in the October 2010 Worldappear unlikely to derail the recovery. In advanced Economic Outlook, and so far has been only partlyeconomies, the decreasing share of oil, the disap- heeded: increased clarity on banks’ balance sheetpearance of wage indexation, and the anchoring exposures and ready recapitalization plans if needed;of inflation expectations all combine to suggest smart fiscal consolidation that is neither too fast,there will be only small effects on growth and core which could kill growth, nor too slow, which wouldinflation. The challenge will be stronger however kill credibility; the redesign of financial regula-in emerging and developing economies, where the tion and supervision; and, especially in Europe,consumption share of food and fuel is larger and an increased focus on reforms to increase potentialthe credibility of monetary policy is often weaker. growth.Inflation may well be higher for some time but, In emerging market economies, by contrast,as our forecasts suggest, we do not expect a major the crisis left no lasting wounds. Their initial fiscaladverse effect on growth. However, risks to the and financial positions were typically stronger, andrecovery from additional disruptions to oil supply the adverse effects of the crisis were more muted.are a concern. High underlying growth and low interest rates are The recovery, however, remains unbalanced. making fiscal adjustment much easier. Exports have In most advanced economies, output is still far largely recovered, and whatever shortfall in externalbelow potential. Unemployment is high, and low demand they experienced has typically been madegrowth implies that it will remain so for many years up through increases in domestic demand. Capital International Monetary Fund | April 2011 xv

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERY outflows have turned into capital inflows, due to Overall, the macro policy agenda for the world both better growth prospects and higher interest economy remains the same but, with the passage of rates than in the advanced economies. time, more urgent. For the recovery to be sustained, The challenge for most emerging market advanced economies must achieve fiscal consolida- economies is thus quite different from that of tion. To do this and to maintain growth, they need the advanced economies—namely, how to avoid to rely more on external demand. Symmetrically, overheating in the face of closing output gaps and emerging market economies must rely less on higher capital flows. Their response should be external demand and more on domestic demand. twofold: first, to rely on a combination of fiscal Appreciation of emerging market economies’ cur- consolidation and higher interest rates to maintain rencies relative to those of advanced economies is an output at potential and, second, to use macropru- important key to this global adjustment. The need dential tools—including, where needed, capital con- for careful design at the national level and coordina- trols—to avoid increases in systemic risk stemming tion at the global level may be as important today from inflows. Countries are often tempted to resist as at the peak of the crisis two years ago. the exchange rate appreciation that is likely to come with higher interest rates and higher inflows. But appreciation increases real income, is part of the Olivier Blanchard desirable adjustment, and should not be resisted. Economic Counsellorxvi International Monetary Fund | April 2011

EXECUTIVE SUMMARY he recovery is gaining strength, but bly for oil, and, relatedly, geopolitical uncertainty,T unemployment remains high in advanced economies, and new macroeconomic risks are building in emerging marketeconomies. In advanced economies, the hand-off from public to private demand is advancing, as well as overheating and booming asset markets in emerging market economies. However, there is also the potential for upside surprises to growth in the short term, owing to strong corporate balance sheets in advanced economies and buoyant demand inreducing concerns that diminishing fiscal policy emerging and developing economies.support might cause a “double-dip” recession. Many old policy challenges remain unaddressedFinancial conditions continue to improve, although even as new ones come to the fore. In advancedthey remain unusually fragile. In many emerging economies, strengthening the recovery will requiremarket economies, demand is robust and over- keeping monetary policy accommodative as long asheating is a growing policy concern. Developing wage pressures are subdued, inflation expectationseconomies, particularly in sub-Saharan Africa, have are well anchored, and bank credit is sluggish. Atalso resumed fast and sustainable growth. Rising the same time, fiscal positions need to be placed onfood and commodity prices pose a threat to poor sustainable medium-term paths by implementinghouseholds, adding to social and economic tensions, fiscal consolidation plans and entitlement reformsnotably in the Middle East and North Africa. Oil supported by stronger fiscal rules and institutions.price increases since January 2011 and information This need is particularly urgent in the United Stateson supply, including on spare capacity, suggest that to stem the risk of globally destabilizing changes inthe disruptions so far would have only mild effects bond markets. The U.S. policy plans for 2011 haveon economic activity. An earthquake in Japan has actually switched back from consolidation to expan-exacted a terrible human toll. Its macroeconomic sion. Efforts should be made to reduce the pro-impact is projected to be limited, although uncer- jected deficit for fiscal year 2011. Measures to trimtainty remains elevated. Overall, with the recovery discretionary spending are a move in this direction.stronger on the one hand but oil supply growth However, to make a sizable dent in the projectedlower on the other, projections for global real GDP medium-term deficits, broader measures such asgrowth in 2011–12 are little changed from the Social Security and tax reforms will be essential. InJanuary 2011 WEO Update. But downside risks Japan, the immediate fiscal priority is to supporthave risen. reconstruction. Once reconstruction efforts are under World real GDP growth is forecast to be about way and the size of the damage is better understood,4½ percent in 2011 and 2012, down modestly from attention should turn to linking reconstruction5 percent in 2010. Real GDP in advanced economies spending to a clear fiscal strategy for bringing downand emerging and developing economies is expected the public debt ratio over the medium term. Into expand by about 2½ percent and 6½ percent, the euro area, despite significant progress, marketsrespectively. Downside risks continue to outweigh remain apprehensive about the prospects of countriesupside risks. In advanced economies, weak sovereign under market pressure. For them what is needed atbalance sheets and still-moribund real estate markets the euro area level is sufficient, low-cost, and flexiblecontinue to present major concerns, especially in funding to support strong fiscal adjustment, bankcertain euro area economies; financial risks are also to restructuring, and reforms to promote competitive-the downside as a result of the high funding require- ness and growth. More generally, greater trust needsments of banks and sovereigns. New downside risks to be reestablished in euro area banks through ambi-are building on account of commodity prices, nota- tious stress tests and restructuring and recapitalization International Monetary Fund | April 2011 xvii

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERY programs. Moreover, reform of the global financial unusually low levels, volatile flows may again exit the system remains very much a work in progress. emerging market economies. Depending on country- The challenge for many emerging and some devel- specific circumstances, and assuming appropriate oping economies is to ensure that present boom-like macroeconomic and prudential policies are in place, conditions do not develop into overheating over measures designed to curb capital inflows can play a the coming year. Inflation pressure is likely to build role in dampening the impact of their excessive vola- further as growing production comes up against tility on the real economy. However, such measures capacity constraints, with large food and energy are not a substitute for macroeconomic tightening. price increases, which weigh heavily in consump- Greater progress in advancing global demand tion baskets, motivating demands for higher wages. rebalancing is essential to put the recovery on a Real interest rates are still low and fiscal policies stronger footing over the medium term. This will appreciably more accommodative than before the require action by many countries, notably fiscal crisis. Appropriate action differs across economies, adjustment in key external deficit economies and depending on their cyclical and external conditions. greater exchange rate flexibility and structural reforms However, a tightening of macroeconomic policies is that eliminate distortions that boost savings in key needed in many emerging market economies. surplus economies. • For external surplus economies, many of which There is broad agreement on the contours of the manage their currencies and do not face fiscal policy responses sketched here. However, with the problems, removal of monetary accommodation peak of the crisis now past, the imperative for action and appreciation of the exchange rate are necessary and willingness to cooperate among policymakers to maintain internal balance––reining in inflation is diminishing. It would be a mistake for advanced pressure and excessive credit growth––and assist in economies to delay fiscal adjustment in the face of global demand rebalancing. a difficult political economy at home. Additionally, • Many external deficit economies need to tighten while the removal of distortions that boost saving fiscal and monetary policies, possibly tolerating in key external surplus economies would support some overshooting of the exchange rate in the growth and help achieve fiscal consolidation in key short term. advanced economies, insufficient progress on one • For some surplus and deficit economies, rapid front should not serve as an excuse for inaction credit and asset price growth warn of a threat to on the other front. It would also be a mistake for financial stability. Policymakers in these economies emerging market economies to delay exchange rate will need to act soon to safeguard stability and adjustment in the face of rising inflation pressure. build more resilient financial systems. Many emerging market economies cannot afford to • Many emerging and developing economies will delay additional policy tightening until the advanced need to provide well-targeted support for poor economies undertake such tightening themselves. households that struggle with high food prices. The task facing policymakers is to convince their Capital flows to emerging market economies national constituencies that these policy responses resumed remarkably quickly after the crisis. However, are in their best economic interests, regardless of the as policy rates in advanced economies rise from their actions others are taking.xviii International Monetary Fund | April 2011

1 HAPTERCHAPTER GLOBAL PROSPECTS AND POLICIES The Recovery Has Solidified, but evidence of tightening capacity constraints, and Unemployment Remains High many face large food price increases, which present other social challenges. The global recovery is continuing broadly as antici- • Overall, growth is insufficiently strong to make a pated in the October 2010 and January 2011 World major dent in high unemployment rates (Figure Economic Outlook (WEO) projections (Figure 1.1; 1.1, top panel). Some 205 million people are Table 1.1). World growth decelerated to about still looking for jobs, which is up by about 30 3¾ percent during the second half of 2010, from million worldwide since 2007, according to the about 5¼ percent during the first half. This slowdown International Labor Organization. The increase in reflects a normal inventory cycle. As fears of a global unemployment has been very severe in advanced depression receded in 2009, businesses at first slowed economies; in emerging and developing econo- their rate of destocking, and then, as confidence mies, high youth unemployment is a particular continued to improve, began to rebuild depleted concern, as noted above. inventories. This fostered a sharp rebound in indus- The recovery is broadly moving at two speeds, trial production and trade, which lasted through the with large output gaps in advanced economies and first half of 2010. As this phase progressed, inventory closing or closed gaps in emerging and developing rebuilding and, as a consequence, industrial produc- economies, but there are appreciable differences tion and trade moved into lower gear in the second among each set of countries (Chapter 2). Economies half of last year. In the meantime, however, reduced that are running behind the global recovery typically excess capacity, accommodative policies, and further suffered large financial shocks during the crisis, often improvements in confidence and financial condi- related to housing booms and high external indebt- tions encouraged investment and sharply reduced the edness. Among the advanced economies, those in rate of job destruction. Consumption also regained Asia have experienced a strong rebound (Figure 1.1, strength. Consequently, the recovery has become bottom left panel). The recovery of euro area econo- more self-sustaining, risks of a double-dip recession in mies that suffered housing busts or face financial advanced economies have receded, and global activity market pressures has been weaker than in Germany seems set to accelerate again. and some other euro area economies. Among emerg- Nonetheless, the pace of activity remains geo- ing and developing economies, those in Asia are in graphically uneven, with employment lagging. the lead, followed by those in sub-Saharan Africa, • In major advanced economies, economic growth whereas those in eastern Europe are only just begin- is modest, especially considering the depth of the ning to enjoy significant growth. recession, reaching just 3 percent in 2010. In the United States and the euro area, the economy is following a path as weak as that following the Financial Conditions Are Improving recessions of the early 1990s, despite a much Reinforcing and reflecting generally positive out- deeper fall (Figure 1.1, middle panel). comes, strong profits have spurred equity price gains • In contrast, many emerging and developing and lowered bond prices, and volatility has decreased economies have seen robust growth, reaching (Figure 1.2, top and bottom panels). Stock prices more than 7 percent in 2010, and have low in emerging Asia, Latin America, and the United unemployment rates, although unemployment States have approached precrisis peaks (Figures 1.2 tends to disproportionately affect young people. and 1.3, top panels). Financial stocks in the euro In a growing number of these economies, there is area, however, have been sluggish, reflecting contin- International Monetary Fund | April 2011 1

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERYTable 1.1. Overview of the World Economic Outlook Projections(Percent change unless noted otherwise) Year over Year Difference from January Q4 over Q4 Projections 2011 WEO Projections Estimates Projections 2009 2010 2011 2012 2011 2012 2010 2011 2012World Output1 –0.5 5.0 4.4 4.5 0.0 0.0 4.7 4.5 4.4 Advanced Economies –3.4 3.0 2.4 2.6 –0.1 0.1 2.7 2.6 2.5 United States –2.6 2.8 2.8 2.9 –0.2 0.2 2.7 3.0 2.7 Euro Area2 –4.1 1.7 1.6 1.8 0.1 0.1 2.0 1.5 2.1 Germany –4.7 3.5 2.5 2.1 0.3 0.1 4.0 1.9 2.5 France –2.5 1.5 1.6 1.8 0.0 0.0 1.5 1.7 2.0 Italy –5.2 1.3 1.1 1.3 0.1 0.0 1.5 1.3 1.2 Spain –3.7 –0.1 0.8 1.6 0.2 0.1 0.6 1.1 1.9 Japan –6.3 3.9 1.4 2.1 –0.2 0.3 2.5 2.5 1.3 United Kingdom –4.9 1.3 1.7 2.3 –0.3 0.0 1.5 2.2 2.4 Canada –2.5 3.1 2.8 2.6 0.5 –0.1 3.2 2.8 2.5 Other Advanced Economies3 –1.2 5.7 3.9 3.8 0.1 0.1 4.8 4.3 3.7 Newly Industrialized Asian Economies –0.8 8.4 4.9 4.5 0.2 0.2 6.1 5.9 3.8 Emerging and Developing Economies4 2.7 7.3 6.5 6.5 0.0 0.0 7.4 6.9 6.9 Central and Eastern Europe –3.6 4.2 3.7 4.0 0.1 0.0 3.7 3.7 4.0 Commonwealth of Independent States –6.4 4.6 5.0 4.7 0.3 0.1 4.7 4.5 3.7 Russia –7.8 4.0 4.8 4.5 0.3 0.1 4.7 4.3 3.5 Excluding Russia –3.1 6.0 5.5 5.1 0.4 –0.1 ... ... ... Developing Asia 7.2 9.5 8.4 8.4 0.0 0.0 9.2 8.4 8.5 China 9.2 10.3 9.6 9.5 0.0 0.0 9.8 9.4 9.5 India 6.8 10.4 8.2 7.8 –0.2 –0.2 9.7 7.7 8.0 ASEAN-55 1.7 6.9 5.4 5.7 –0.1 0.0 6.1 5.4 5.6 Latin America and the Caribbean –1.7 6.1 4.7 4.2 0.4 0.1 5.2 5.0 4.6 Brazil –0.6 7.5 4.5 4.1 0.0 0.0 5.0 5.0 4.0 Mexico –6.1 5.5 4.6 4.0 0.4 –0.8 4.4 4.4 3.7 Middle East and North Africa 1.8 3.8 4.1 4.2 –0.5 –0.5 ... ... ... Sub-Saharan Africa 2.8 5.0 5.5 5.9 0.0 0.1 ... ... ... Memorandum European Union –4.1 1.8 1.8 2.1 0.1 0.1 2.1 1.8 2.4 World Growth Based on Market Exchange Rates –2.1 3.9 3.5 3.7 0.0 0.1 ... ... ...World Trade Volume (goods and services) –10.9 12.4 7.4 6.9 0.3 0.1 ... ... ...Imports Advanced Economies –12.6 11.2 5.8 5.5 0.3 0.3 ... ... ... Emerging and Developing Economies –8.3 13.5 10.2 9.4 0.9 0.2 ... ... ...Exports Advanced Economies –12.2 12.0 6.8 5.9 0.6 0.1 ... ... ... Emerging and Developing Economies –7.5 14.5 8.8 8.7 –0.4 –0.1 ... ... ...Commodity Prices (U.S. dollars)Oil6 –36.3 27.9 35.6 0.8 22.2 0.5 ... ... ...Nonfuel (average based on world commodity export weights) –15.8 26.3 25.1 –4.3 14.1 1.3 ... ... ...Consumer PricesAdvanced Economies 0.1 1.6 2.2 1.7 0.6 0.1 1.6 2.2 1.5Emerging and Developing Economies4 5.2 6.2 6.9 5.3 0.9 0.5 6.3 5.9 4.2London Interbank Offered Rate (percent)7On U.S. Dollar Deposits 1.1 0.5 0.6 0.9 –0.1 0.0 ... ... ...On Euro Deposits 1.2 0.8 1.7 2.6 0.5 0.9 ... ... ...On Japanese Yen Deposits 0.7 0.4 0.6 0.3 0.0 0.1 ... ... ... Note: Real effective exchange rates are assumed to remain constant at the levels prevailing during February 8–March 8, 2011. When economies are not listed alphabetically, they are orderedon the basis of economic size. The aggregated quarterly data are seasonally adjusted. 1The quarterly estimates and projections account for 90 percent of the world purchasing-power-parity weights. 2Excludes Estonia. 3Excludes the United States, Euro Area, and Japan but includes Estonia. 4The quarterly estimates and projections account for approximately 79 percent of the emerging and developing economies. 5Indonesia, Malaysia, Philippines, Thailand, and Vietnam. 6Simple 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 $79.03 in 2010; the assumed price based onfutures markets is $107.16 in 2011 and $108.00 in 2012. 7Six-month rate for the United States and Japan. Three-month rate for the Euro Area.

CHAPTER 1 GLOBAL PROSPECTS AND POLICIESued vulnerability to peripheral euro area economies(Figure 1.2, middle panel). Government bond and Figure 1.1. Global Indicatorsbank credit default swap spreads in peripheral euro (Annual percent change unless noted otherwise)area economies remain high, pointing to significant Global activity has evolved broadly in line with the October 2010 WEO forecast.vulnerabilities (Figure 1.4, middle panel). Stocks Growth is low in advanced economies and unemployment is high. In the Unitedin Japan are lagging because of the appreciation of States and the euro area, the recoveries are tracking those of the 1990s, despite much deeper falls in output during the Great Recession. Emerging and developingthe yen and the impact of the recent earthquake. economies that have not been hit hard by the crisis are already in expansionaryCredit growth remains very subdued in the advanced territory.economies. Bank lending conditions in the major 8 GDP Growth Unemployment Rate 9advanced economies, including those of the euro 2010area, are slowly easing after a prolonged period of 2011 October 2010 WEO Emerging andincremental tightening (Figure 1.4, top panel); for 6 8 developingsmall and medium-size firms, they are easing or economiestightening only modestly. In the meantime, credit 4 7growth has again reached high levels in many emerg-ing market economies, particularly in Asia and Latin 2 6 AdvancedAmerica (Figure 1.3, bottom panel). economies Global capital flows rebounded sharply following 0 5 World Advanced Emg. and 2000 05 10 15the collapse during the crisis, but they are still below economies dev. econ.precrisis averages in many economies (Figure 1.5, Output since Trough for Highly Synchronized Recessionsmiddle and bottom panels; Chapter 4). Accord- (index; quarters from trough on x-axis)ingly, stock markets and credit in emerging market 114 United States Euro Area 114economies have rebounded unusually fast from 112 1975:Q1 1975:Q1 112deep falls (Box 1.1). Strong growth prospects and 110 1982:Q3 1982:Q3 110 1991:Q1 1993:Q1relatively high yields are attracting flows into emerg- 108 2009:Q2 2009:Q2 108ing markets. Sluggish activity and damaged financial 106 106systems continue to depress flows between advanced 104 104economies. These forces raise policy challenges that 102 102are discussed in more detail later in this chapter as 100 100well as in the April 2011 Global Financial Stability 98 98 -4 -2 0 2 4 6 8 -4 -2 0 2 4 6 8Report.• Capital flows to some larger emerging market Change in GDP1 Change in GDP2 110 130 economies—for example, Brazil, China, India, (2010:Q4 GDP in percent of (2010:Q4 GDP in percent of 2008:Q2 GDP) 2008:Q2 GDP) 125 Indonesia, Mexico, Peru, Poland, and Turkey––are 105 120 all within the range of or above precrisis levels. 115 The recovery has been led so far by portfolio and 100 110 bank flows, with a falling share of foreign direct 105 investment inflows. These developments mark a 95 100 departure from earlier experience and may raise the 95 risk of future instability, including capital outflows. 90 90 However, during fall 2010 the capital-flow-driven US EA/G/F/I/S JP OAAE EAS LA CEE MENA SSA and CIS rally in emerging market assets slowed again. Other regions, such as east and west Africa, have yet to Source: IMF staff estimates. see much of a rebound in capital inflows. 1 US: United States; EA/G/F/I/S: euro area/Germany/France/Italy/Spain; JP: Japan; OAAE: other advanced Asian economies.• Flows between advanced economies have been 2 EAS: emerging Asia; LA: Latin America; CEE and CIS: central and eastern Europe and hit hard by the financial disintermediation Commonwealth of Independent States; MENA: Middle East and North Africa; SSA: sub-Saharan Africa. Due to data limitations, annual data are used for MENA and SSA. wrought by the crisis (Figure 1.5, middle panel). International Monetary Fund | April 2011 3

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERY Capital flows from the United States have returned to precrisis levels but have been redi- Figure 1.2. Recent Financial Market Developments rected to emerging market economies and away from advanced economies. Capital flows from Equity prices have moved close to precrisis peaks in the United States but are lagging in Europe and Japan, reflecting, respectively, concerns about the financial sector and the euro area, especially via banks, are still well exports. Volatility has receded. Corporate spreads have returned to a low level. below precrisis levels. Reduced flows to other Long-term government bond yields have moved up in response to stronger activity but remain below levels reached in early 2010. advanced economies account for most of this reduction, although flows to emerging market Equity Markets Implied Volatility1 economies are also weak. 120 (2007 = 100; national currency) (percent) May 10, 2010 90 110 80 Changes in financial conditions are unlikely 100 70 to give significant additional support to output U.S. (VIX) 90 S&P 60 growth over the near term. Given the state of the 80 500 50 “real” recovery, risk aversion and volatility are 70 40 already low in the major financial markets, as evi- 60 30 denced by the vigorous recovery of equity markets DJ Euro 50 Topix Stoxx 20 and a narrowing of credit risk spreads. Although 40 10 bank lending conditions in advanced economies Emerging markets (VXY) 30 0 2000 02 04 06 08 Mar. 2000 02 04 06 08 Mar. are still far from normal, further progress is likely 11 11 to be slow. Securitization markets remain in disre- pair. Banks will need time to switch toward more MSCI Daily Change Differences MSCI Daily Change Differences (Jan. 1, 2010 = 100) (Jan. 1, 2010 = 100) stable deposits and long-term wholesale funding. 104 115 World consumer Supervision and regulation are being tightened discretionary 100 –World total for good reason. In addition, conditions are likely Euro total– 110 96 World total to remain volatile because of continued uncer- 105 tainty about how the crisis in the euro area will 92 be resolved. Indices of broad financial conditions 100 88 compiled by the IMF staff confirm this qualitative 84 Euro financial– World financial 95 reading. They suggest that conditions are easing –World total World financial slowly and to a similar degree in the United States, 80 90 Jan. Apr. Jul. Oct. Jan. Mar. Jan. Apr. Jul. Oct. Jan. Mar. the euro area, and Japan; simple forecasts point to 2010 10 10 10 11 11 2010 10 10 10 11 11 further, very gradual easing (Figure 1.4, bottom 2 Corporate Spreads panel; Appendix 1.1). 6 Government Bond Yields 1800 United (basis points; averages of Robust capital flows to key emerging market Europe and United States) 5 States 1500 economies may well continue, although questions 1200 about macroeconomic policies and geopolitical 4 uncertainty could slow flows over the near term. 3 Germany 900 The growth differential between these economies 2 600 and advanced economies is not forecast to dimin- BB ish significantly. Together with emerging economies’ 1 Japan 300 AAA demonstrated resilience during the financial crisis, 0 2002 04 06 08 Mar. 2000 02 04 06 08 0 Mar. this supports further structural reallocation of port- 11 11 folios toward these economies. However, uncertainty about the extent and possibility of policy rate hikes Sources: Bloomberg Financial Markets; and IMF staff calculations. 1VIX = Chicago Board Options Exchange Market Volatility Index; VXY = JPMorgan in the face of rising inflation may already be acting Emerging Market Volatility Index. as a brake on such flows, as is heightened geopo- 2Ten-year government bonds. litical uncertainty. A strengthening recovery in the United States, rising yields (Chapter 4), and renewed4 International Monetary Fund | April 2011

CHAPTER 1 GLOBAL PROSPECTS AND POLICIESuncertainty in the euro area could also temper suchflows in the future. Figure 1.3. Emerging Market Conditions Equity prices in Asia and Latin America are close to precrisis peaks. In addition,Commodity Prices Are Resurgent credit spreads have returned to low levels, capital flows have picked up remarkably quickly, and private sector credit growth is reaching high levels again in many Commodity prices have quickly returned to high emerging market economies.levels, owing to structural as well as cyclical andspecial factors, and market pressures remain elevated. 150 Equity Markets Interest Rate Spreads 1600 (2007 = 100; (basis points)The key structural change is rapid growth in emerg- national currency) Latin 125 America United States BBing and developing economies, which has lifted 1200and changed the pattern of commodity consump- 100tion. At the same time, supply responses have been 75 800 Sovereign1slow, with production running into sharply higher Asiamarginal costs. The key cyclical factor was stronger- 50 Eastern Corporate2 Europe 400than-expected growth in demand for commodities 25 AAAduring the second half of 2010, which drove up oil 0 0prices for 2011 to about $90 a barrel by early Janu- 2002 04 06 08 Mar. 2002 04 06 08 Mar. 11 11ary 2011, up from the $83 a barrel expected in April Emerging Market Issuance New Issues by Region 32010. Special factors include the Organization of 240 (billions of U.S. dollars) (billions of U.S. dollars) 240Petroleum Exporting Countries’ (OPEC’s) lower- Western Hemisphere 200 Equities Middle East and North Africa 200than-expected output response when prices rose Bonds Europe 4 Syndicated loans Developing Asiaabove $70–$80, a price range previously declared 160 Sub-Saharan 160to be “fair,” which increased market concern about Africa 120 120supply. Another special factor has been unrest in theMiddle East and North Africa since January 2011. 80 80For food, the main special factor was weather-related 40 40supply shocks. 0 0 Stronger-than-anticipated global demand for com- 2005 06 07 08 09 10: 2002 04 06 08 10: Q4 Q4modities has reduced inventories and caused a strong,sustained, and broad-based increase in prices (Appen- Private Credit Growth 5 60dix 1.2). The overall IMF commodity price index rose Latin America China 50by 32 percent from the middle of 2010 to February Asia excluding 402011—recuperating about three-quarters of the 55 Eastern China Europe 30percent decline after the cyclical peak in July 2008 20through early 2009. Food prices are within reach oftheir 2008 peaks. Fortunately, good harvests in sub- 10Saharan Africa have offered a measure of protection 0to some of the world’s poor. However, social unrest in -10the Middle East and North Africa could place further -20 2002 03 04 05 06 07 08 09 Jan.upward pressure on food prices if the governments 11of large grain importers inside and outside the region Sources: Bloomberg Financial Markets; Capital Data; IMF, International Financialstep up their purchases to ensure sufficient supply in Statistics; and IMF staff calculations. 1JPMorgan EMBI Global Index spread.these subsidized domestic food markets. 2 JPMorgan CEMBI Broad Index spread. Commodity supplies are expected to respond to 3 Total of equity, syndicated loans, and international bond issues. 4 Central and eastern Europe and Commonwealth of Independent States.higher prices in 2011. There is spare capacity in the 5 Annualized percent change of three-month moving average over previous three-monthenergy sector, which could make up for production moving average.losses on account of civil war in Libya, and an International Monetary Fund | April 2011 5

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERY anticipated return to more normal weather conditions Figure 1.4. Developments in Mature Credit Markets should result in increased agricultural output. At the Bank lending conditions either are no longer tightening significantly or are easing same time, demand growth should moderate some- again, but credit growth rates remain very low. The main concerns with respect to global financial stability stem from very high funding requirements of banks and what, reflecting usual cyclical patterns. These develop- sovereigns, especially in peripheral countries of the euro area. Further gradual easing of credit conditions can be expected. ments are forecast to allow for more balanced growth 1 in both supply and demand. Nonetheless, the outlook 100 Bank Lending Conditions -15 Private Credit Growth2 30 for oil markets remains quite uncertain, as perceptions 80 Euro area -10 United of geopolitical supply risks can be volatile. (left scale) Euro area States 20 60 -5 • Crude oil supply is responding sluggishly to 40 0 10 the ongoing pickup in demand, largely reflecting the policy stance of OPEC. Constraints on 20 5 0 non-OPEC capacity and disruption of produc- 0 10 United Japan Japan tion in Libya mean that the call on other OPEC -10 -20 States (inverted; 15 suppliers will increase in 2011.1 Current OPEC (left scale) right scale) -40 2000 02 04 06 08 11: 20 2000 02 04 06 08 -20 Feb. spare capacity levels, estimated at about 4½ Q1 Government Bond Spreads 11 percent of global demand, are sufficient to make Bank CDS3 Spreads (two-year yield spreads over up for losses of supply from Libya and to meet 400 (ten-year, median; in basis 900 German bunds; basis points) 2000 points) Greece the expected increase in demand. If the supply 750 (right scale) response materializes, it should restrain further Ireland 1600 300 Portugal upward price pressure. Current WEO projections United 600 Spain States 1200 are based on futures market prices during March 200 450 2011, which saw oil prices stabilizing at about Euro 800 area 300 $108 a barrel, some 35 percent above 2010 levels, 100 150 400 or some 20 percent above levels assumed for 2011 May 10, 2010 in the January 2011 WEO Update. 0 0 0 2003 04 05 06 07 08 09 Mar. Jan. Apr. July Oct. Jan. Mar. • Global food output should recover quickly from 11 2010 11 11 Financial Conditions Index4 recent supply shocks, with increased global acreage (positive = tightening; standard deviations from average) and more normal weather conditions pointing to 5 United States Euro Area 5 favorable harvest prospects in 2011. Low inven- 4 Spreads Spreads 4 tories will take time to rebuild, and so prices are Prices Prices Quantities Quantities likely to remain more volatile than usual. Govern- 3 3 2 2 ments will need to ensure that the poor have sufficient access to food while food prices stay high. 1 1 Regarding medium-term prospects for key com- 0 0 modities, genuine resource scarcity concerns are -1 -1 now widespread (Chapter 3). A gradual, signifi- -2 2000 02 04 06 08 10 12: 2000 02 04 06 08 10 -2 12: cant downshift in oil supply trend growth is quite Q4 Q4 possible but might present only a limited drag on Sources: Bank of America/Merrill Lynch; Bank of Japan; Bloomberg Financial Markets; annual global growth of less than ¼ percent in the European Central Bank; Federal Reserve; Haver Analytics; Thomson Datastream; and IMF medium term. This relatively small effect reflects the staff calculations. 1 Percent of respondents describing lending standards as tightening “considerably” or small share of oil in overall economic production “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 and consumption and the scope to adjust produc- credit to firms for the euro area; average of surveys on changes in credit standards for tion and consumption to rising prices over the long commercial/industrial and commercial real estate lending for the United States; diffusion index of “accommodative” minus “severe,” Tankan survey of lending attitudes of financial term. However, given low (and falling) short-term institutions, for Japan. 2 Annualized percent change of three-month moving average over previous three-month 1The “call on OPEC” is the difference between global demand moving average. 3 CDS = credit default swap. and supply from sources other than OPEC crude oil production, 4 Historical data are monthly, and forecasts (dashed lines) are quarterly. including OPEC natural gas liquids (NGL) production.6 International Monetary Fund | April 2011

CHAPTER 1 GLOBAL PROSPECTS AND POLICIESsupply and demand elasticities, such a trend could Figure 1.5. Current and Forward-Looking Tradealso bring abrupt price changes that could have very Indicators1damaging short-term effects on economic activity. (Annualized percent change of three-month moving average over previous three-month moving average unless noted otherwise) World trade and industrial production slowed during 2010:H2, reflecting a global inventoryThe Recovery Is Expected to Solidify cycle. Imports of emerging and developing economies are back to precrisis trends, but those in advanced economies continue to lag. Capital flows from advanced to emerging economies have picked up. However, according to some measures they slowed down Given the improvement in financial markets, buoy- during fall 2010. Flows between advanced economies remain in the doldrums.ant activity in many emerging and developing econo- World Trade Industrial Productionmies, and growing confidence in advanced economies, 60 Emerging Asia3 30 Worldeconomic prospects for 2011–12 are good, notwith- 40 20 Trade value2standing new volatility caused by fears about disrup- 20 10tions to oil supply. As in the January WEO Update, 0 0activity is projected to pick up from the recent dip, Emerging -20 economies 4 -10with global growth reaching about 4½ percent during CPB trade -40 volume index Advanced 5 -202011–12 (see Table 1.1; Figure 1.6, top panel). Real economies -60 -30GDP is expected to expand by about 2½ percent in 2000 02 04 06 08 Jan. 2005 06 07 08 09 Jan. 11 11advanced economies and by 6½ percent in emerging 6 Capital Outflows: 2010 versus 5.6 Imports 1400and developing economies. This entails a modest slow- 2006–077 5.4 2010 (Q1–Q2) 1200 Emergingdown relative to the growth rates reached in 2010. 5.2 economies 2006–07 1000 Leading indicators already show evidence of 5 800a pickup in growth following the inventory-led 4.8 600slowdown. After stagnating during much of the fall, 4.6 Advanced 400 economiesindustrial production has begun to regain speed, 4.4 200reflected in the return of manufacturing purchas- 4.2 0 1997 2000 03 0609 Jan. AE8 EM9 AE8 EM9ing managers indices (PMIs) to more expansionary 11 United States Euro arealevels (Figure 1.7, top panel). Service sector PMIs Net Fund Flows to Emerging Markets (billions of U.S. dollars; weekly flows)suggest that the recovery is now broadening to this Bond Funds Equity Funds 2.0 Ireland QE2 Ireland 8large part of the global economy. Retail sales are crisis Greece (Nov. 3) crisis 6going strong in emerging market economies and 1.5 crisis 4have bounced back in advanced economies, led by 1.0 2the United States (Figure 1.7, middle panel). At 0.5 0the same time, the impact of recent oil price hikes -2 0.0 Global QE2 Asia excl. Japan -4is expected to be relatively limited.2 A much wider -0.5 Greece (Nov. 3) Latin America -6reading of coincident indicators, summarized in the crisis EMEA10 -1.0 -8 Jan. Apr. Jul. Oct. Jan. Mar. Jan. Apr. Jul. Oct. Jan. Mar.IMF’s Growth Tracker, confirms a return of momen- 10 11 11 10 11 11tum (Figure 1.8, top panel). Sources: Bureau of Economic Analysis; U.S. Treasury; EPFR Global; European Central Bank; Haver Analytics; Netherlands Bureau for Economic Policy Analysis for CPB trade volume index; and IMF staff calculations. 1Not all economies are included in the regional aggregations. For some economies, 2Oil factor shares would imply output losses of a bit more than monthly data are interpolated from quarterly series.½ percentage point, assuming the price increases during Febru- 2 In SDR terms. 3 China, India, Indonesia, Malaysia, Philippines, and Thailand.ary and March are permanent. There are, however, important 4 Argentina, Brazil, Bulgaria, Chile, China, Colombia, Hungary, India, Indonesia, Latvia,mitigating factors that would noticeably lower the effect on global Lithuania, Malaysia, Mexico, Pakistan, Peru, Philippines, Poland, Romania, Russia, Southgrowth. Fuel subsidies in many emerging and developing econo- Africa, Thailand, Turkey, Ukraine, and Venezuela.mies insulate end-users from increases in world oil prices at least 5 Australia, Canada, Czech Republic, Denmark, euro area, Hong Kong SAR, Israel, Japan,temporarily. The terms-of-trade gains of oil exporters will lead Korea, New Zealand, Norway, Singapore, Sweden, Switzerland, Taiwan Province of China, United Kingdom, and United States.to higher imports from oil importers as will higher government 6 Actual (solid line) versus 1997–2006 log linear trend (dashed line).spending on social programs in some Middle Eastern economies. 7 Billions of U.S. dollars for the United States and euros for euro area, annualized. 8 AE = advanced economies.Finally, with the supply disruption expected to ease somewhat 9 EM = emerging market economies.throughout the year, end-users could well accommodate higher oil 10EMEA = Europe, Middle East, and Africa.expenditures in part by drawing on savings. International Monetary Fund | April 2011 7

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERY Figure 1.6. Global Outlook Various forces are interacting to propel the (Real GDP; quarterly percent change from one year earlier unless noted recovery: otherwise) • In advanced economies, investment is recovering with the rebound of industrial production Global growth is forecast to reaccelerate. However, the recovery will remain because capital stocks are down and little excess two-speed in nature, with emerging and developing economies posting strong growth but not advanced economies. Activity is forecast to moderate somewhat in capacity remains (Figures 1.7 and 1.8, bottom emerging Asia and Latin America, following strong rebounds, as capacity constraints panels). The rebound in production is benefit- begin to bind. ing from low interest rates, easing financing conditions, and generally healthy corporate 10 Emerging United States 6 economies1,2 balance sheets and profitability. At the same 8 3 time, consumption is being spurred by reduced 6 World 2 0 job layoffs, the gradual recovery of employ- 4 Japan Euro ment, and previously postponed purchases of 2 -3 area durable goods.3 Household saving rates are not 0 Advanced -6 projected to rise much over the next couple years -2 economies 2,3 -9 (Figure 1.9, middle panel). Deleveraging is thus -4 expected to continue at its present pace, except -6 -12 2000 02 04 06 08 10 12 2000 02 04 06 08 10 12 in a few economies in the euro area that are 16 still struggling with the crisis (Figure 1.9, lower China 16 India panel). 12 12 • In much of Latin America and Asia and in Emerging Europe6 8 8 low-income countries in sub-Saharan Africa, recovery has brought output back to precri- 4 4 sis peaks, and many economies have already ASEAN-4 4 Brazil 0 0 moved into expansion territory (Figure 1.6, NIEs 5 Latin America7 middle and bottom panels). Activity in these -4 -4 economies is being boosted by accommoda- -8 -8 2000 02 04 06 08 10 12 2000 02 04 06 08 10 12 tive macroeconomic policies, rising exports and 16 8 commodity prices, and—in several—capital inflows. Growth in sub-Saharan Africa is also 12 7 CIS8 projected to stay high, reflecting sustained 8 6 strength in domestic demand and rising global Russia 5 4 Sub-Saharan demand for commodities (Figure 1.6, bottom 4 0 Africa 8 panel). Economic prospects across the Middle 3 -4 Middle East East are quite diverse and still fairly uncertain and North 2 Africa 8 at the time of writing. In eastern European and -8 1 Commonwealth of Independent States (CIS) -12 0 2000 02 04 06 08 10 12 2000 02 04 06 08 10 12 economies that were heavily affected by the crisis, activity is also rebounding. Sources: Haver Analytics; and World Economic Outlook database. 1Comprises China, India, Russia, South Africa, Turkey, and economies listed in footnotes Inflation pressure is forecast to broaden, mainly 4, 6, and 7. 2Includes only economies that report quarterly data. in emerging and developing economies. At the 3Australia, Canada, Czech Republic, Denmark, euro area, Hong Kong SAR, Israel, Japan, global level, headline inflation picked up to 4 per- Korea, New Zealand, Norway, Singapore, Sweden, Switzerland, Taiwan Province of China, United Kingdom, and United States. cent in February, exceeding 2 percent in advanced 4Indonesia, Malaysia, Philippines, and Thailand. 5Newly industrialized Asian economies (NIEs) comprise Hong Kong SAR, Korea, economies and exceeding 6 percent in emerg- Singapore, and Taiwan Province of China. 6Bulgaria, Hungary, Latvia, Lithuania, and Poland. 3Postponement of such purchases led in 2009 to an unusu- 7Argentina, Brazil, Chile, Colombia, Mexico, Peru, and Venezuela. ally large drop in industrial production relative to GDP (see 8Annual percent change from one year earlier. For MENA, aggregated data excludes Libya Figure 1.8, bottom panel). for the forecast years due to the uncertain political situation.8 International Monetary Fund | April 2011

CHAPTER 1 GLOBAL PROSPECTS AND POLICIESing and developing economies (Figure 1.10, top Figure 1.7. Current and Forward-Looking Growthpanel). This reflects mainly the behavior of food Indicators 1and energy prices and the fact that these compo- (Annualized percent change of three-month moving average over previousnents have a higher weight in the consumer price three-month moving average unless noted otherwise)index (CPI) in lower-income countries. Thus, core Forward-looking indicators have remained expansionary, pointing to higher growth ininflation is running well below headline inflation, 2011:H1. Consumption has gradually strengthened in advanced economies. Although investment has recently been less dynamic in these economies, it should pick upalthough it has been rising quickly in emerging and again as production reaccelerates. Indicators point to continued robust activity indeveloping economies, from 2¼ percent in March many emerging and developing economies. Manufacturing Purchasing Global PMI 42010 to 3¾ percent in February 2011. Looking 65 Managers’ Index (PMI) (index) 68 2002–03 averageahead, core inflation is projected to rise further as (index) Emerging 2004–07 average 60 economies2 Latest 64excess capacity is slowly worked off. Headline infla- Manufacturing Services 55tion will still moderate if commodity prices broadly 60 50stabilize as expected. 56 45 Advanced• In advanced economies, headline inflation is pro- economies 3 52 jected to return below 2 percent in 2011, settling 40 at about 1½ percent during the course of 2012 35 48 as food and energy price hikes abate and wages 44 30 2000 02 04 06 08 Feb. Output NE PI Emp. Headline accelerate only gradually amid weak labor markets 11 (see Table 1.1). 6 Employment Retail Sales 36 Emerging Emerging Asia5• In emerging and developing economies, infla- 4 economies2 Emerging 27 tion pressure is broadening (Figure 1.10, top World economies2 2 18 and bottom panels). Assuming broadly stable World food and energy prices, the WEO forecast sees 0 9 headline inflation at close to 7 percent in 2011 -2 0 and receding to below 5 percent in 2012 (see Advanced 3 economies Advanced economies 3 Table 1.1). -4 -9 The forecast assumes that macroeconomic poli- -6 -18 2005 06 07 08 09 Jan. 2005 06 07 08 09 Jan.cies remain generally supportive. For the major 11 11 Real Private Consumption Real Gross Fixed Investmentadvanced economies, financial markets foresee (annualized percent change from (annualized percent change fromonly limited tightening of monetary policies over 12 preceding quarter) preceding quarter) 20the coming year (Figure 1.11, top panel). Fiscal 10policy tightening is projected to be modest in 8 Emerging economies2 02011, following some loosening in 2010 (Figure Emerging1.12, middle panel). Markets also expect only 4 economies2 -10limited removal of monetary accommodation in -20 Advancedemerging and developing economies (Figure 1.11, 0 economies3 Advanced -30bottom panel). Concerns that the global recovery economies3 of which: machinery and equipment 6might be set back by fiscal tightening in advanced -4 2007 08 09 10: 2007 08 09 10: -40economies appear less pertinent. First, the with- Q4 Q4 Sources: Haver Analytics; NTC Economics; and IMF staff calculations.drawal of fiscal stimulus projected for 2011 now 1 Not all economies are included in the regional aggregations. For some economies, monthly data are interpolated from quarterly series.appears limited, reaching only ¼ percent of GDP. 2 Argentina, Brazil, Bulgaria, Chile, China, Colombia, Hungary, India, Indonesia, Latvia,Second, it seems there is a handoff from public Lithuania, Malaysia, Mexico, Pakistan, Peru, Philippines, Poland, Romania, Russia, South Africa, Thailand, Turkey, Ukraine, and Venezuela.to private demand as the driver of growth, even 3 Australia, Canada, Czech Republic, Denmark, euro area, Hong Kong SAR, Israel, Japan,in advanced economies. This is evidenced, for Korea, New Zealand, Norway, Singapore, Sweden, Switzerland, Taiwan Province of China, United Kingdom, and United States.example, by continued recovery in the euro area, 4 NE: new orders; PI: purchased inventory; Emp.: employment. 5 China, India, Indonesia, Malaysia, Philippines, and Thailand.notwithstanding a broadly neutral fiscal stance 6 Purchasing-power-parity weighted averages of metal products and machinery for theduring 2010. euro area, plants and equipment for Japan, plants and machinery for the United Kingdom, and equipment and software for the United States. International Monetary Fund | April 2011 9

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERYFigure 1.8. Prospects for Near-Term Activity Risks Are Smaller but Remain to the DownsideA reading of a large number of indicators for many countries—summarized in thisGrowth Tracker—suggests that activity is reaccelerating in many countries. In The degree of uncertainty about the outlook foradvanced economies, industrial production remains fairly low, considering the state 2011 has declined since the October 2010 Worldof demand as captured by GDP. This is because consumption of durables has beenpostponed, as has investment. Some further catch-up is likely over the coming year. Economic Outlook. However, downside risks have increased relative to the January 2011 WEO Update, Growth Tracker1 Above potential and moderating Below potential and moderating mainly because of geopolitical uncertainty. Above potential and rising Contracting at a moderating rate Below potential and rising Contracting at an increasing rate The fall in uncertainty relative to 2010 is con-Western Hemisphere United States firmed by the distribution of analysts’ forecasts Brazil Mexico Canada for the yield curve and inflation as well as data on Argentina Colombia options prices for the Standard & Poor’s (S&P) 500 Venezuela Peru Chile index and oil, which are summarized in the IMF’s EcuadorDominican Rep. fan chart (Figure 1.13, top panel). In particular, the UruguayAsia Pacific China dispersion of analysts’ forecasts for real GDP growth Japan India is substantially smaller than it was in 2010 and is Korea Indonesia Australia now close to the historical baseline (Figure 1.13, Thailand Philippines bottom panel). The fan chart suggests that markets SingaporeEurope Euro area continue to see a greater potential for upside rather Germany Russia than downside surprises for growth from equityUnited Kingdom France Italy prices (Figure 1.13, middle panel).4 Interestingly, Spain Turkey Sweden although forecasters generally see appreciably higher Greece inflation, they now see more scope for inflation PortugalAfrica South AfricaMiddle East and Central Asia surprises on the downside rather than the upside, Saudi Arabia Kazakhstan which has opposite implications for surprises with Feb. Jul. Jan. Jul. Jan. Jul. Jan. 2008 08 09 09 10 10 11 respect to real GDP growth. However, this result is Real GDP Growth essentially driven by forecasts for the United States, (annualized percent change from previous half year) 5 12 Japan, and China. Advanced economies (left scale) 4 Emerging and developing economies (right scale) 10 The key downside risk to growth relates to the 8 potential for oil prices to surprise further on the 3 6 upside because of supply disruptions. To explore 2 these risks in more detail, the IMF staff developed 4 1 2 a downside scenario under which greater-than- 0 0 expected temporary supply disruptions push oil 2009:H2 10:H1 10:H2 11:H1 11:H2 prices up to an average of $150 per barrel for 2011, Industrial Production and Capacity Utilization 3220 Estimated Trend 2 (standard deviation from average) 4 after which they recede to the average levels cur-200 (index) 2 rently expected for 2012. In advanced economies,180 Emerging 0 the level of real GDP in 2012 would then be160 economies -2 ¾ percent lower than in current WEO projections; United States -4140 Advanced Euro area in emerging and developing economies, the effects economies Japan -6120 Korea would vary widely, from an output loss of close to100 Brazil -8 ¾ percent in Asia and sub-Saharan Africa, to ½ per- 80 -10 cent in Latin America, to output gains in the Middle 2000 02 04 06 08 10: 2000 02 04 06 08 11: Q4 Q1 East and North Africa as well as the Commonwealth Sources: Haver Analytics; and IMF staff estimates. 1The Growth Tracker is described in Matheson (2011). Within regions, countries are of Independent States. Global output losses would listed by economic size. 2Trend (dashed lines) is estimated using a cointegrating relationship of industrial 4 For details on the construction of the fan chart, see Elekdag production with advanced or emerging economy GDP, respectively. 3Data are standardized using averages and standard deviations taken from the 10 years and Kannan (2009). before the crisis.10 International Monetary Fund | April 2011

CHAPTER 1 GLOBAL PROSPECTS AND POLICIESbe much larger in the event of a permanent shock tooil supply. According to the April 2011 Global FinancialStability Report, financial risks have declined since Figure 1.9. Balance Sheets and Saving Rates (Percent)October 2010. Improvements in macroeconomicperformance and strong prospects for emerging mar- Deleveraging is ongoing in many advanced economies, mainly in the household sector.ket assets are supporting overall financial stability. However, saving rates are not expected to rise much over the coming two years, suggesting a gradual rise in consumption as employment picks up. Conditions remainAccommodative macroeconomic conditions are help- vulnerable in peripheral countries of the euro area.ing to ease balance sheet risks and are spurring anincrease in risk appetite. However, significant fiscal Household: Debt-to-Income Household: Growth Rate of Debt 180 20and financial vulnerabilities still lurk behind recent Ratio Stock United (annual rate)benign market developments, especially in the euro 160 Kingdom United States 15area. More generally, downside risks stem from high 140 United Japanleverage and limited improvements in credit quality States 10in advanced economies and gradually building credit 120 United 5risks in some major emerging market economies. 100 Euro Euro Kingdom areaThese are the key downside risks for global economic area 0 80and financial stability: Japan• Weak sovereign balance sheets in advanced econo- 60 2000 02 04 06 08 10: 2000 02 04 06 08 10: -5 mies: Risks relate to the major funding require- Q4 Q4 ments of sovereigns and the potential for high Household: Growth Rate of Debt Household Saving Rate volatility in interest rates and risk premiums. 40 Stock 9 16 Currently, these are focused on vulnerable euro 35 (annual rate) Euro area Japan (right scale) (left scale) area economies (see below). However, risks also 30 Greece flow from fiscal policy in the United States, given 25 6 14 20 large funding requirements and heavy reliance on 15 Spain external sources.5 As discussed in previous issues 10 3 12 of the World Economic Outlook, there is little risk Portugal 5 United of a large, broad-based increase in government 0 States United Kingdom bond rates in the short term, but there is a chance (left scale) (left scale) -5 0 10 2000 02 04 06 08 10: 2000 04 08 12 16 of sudden changes, especially in risk premiums, Q4 that could threaten global financial stability.6 Nonfinancial Corporations: Debt Nonfinancial Corporations: Debt 100 200 5See as a Share of Financial Assets as a Share of Financial Assets Box 1.4 in the October 2010 World Economic Outlook. 6This 180 is because the recovery in advanced economies is forecast 90to be subdued; savings in surplus emerging market economies are United 160 80 Kingdom Portugalprojected to rise relative to investments; and there are few plau- 140sible alternative outlets in emerging market economies to the large Greece 70 120volume of debt instruments issued by advanced economies (see EuroChapter 1 of the October 2010 World Economic Outlook). Look- area 100 60ing further ahead, Dobbs and Spence (2011) argue that the global Japan 80economy will soon have to cope with too little capital, not too Spain 50 60much, as rapid urbanization in emerging and developing econo- United Statesmies boosts demand for infrastructure, while demand rebalancing 40 40 2000 02 04 06 08 10: 2000 02 04 06 08 10:in China and demographic change in advanced economies lower Q4 Q3the supply of savings. However, whether or not real interest ratesrise depends on many factors that are very hard to predict, such Sources: Haver Analytics; and IMF staff estimates.as prospects for investment in aging societies, retirement ages, therelationship between aging and health, financial developmentsin emerging and developing economies, international migration,technological change, and policy responses, to mention just a few. International Monetary Fund | April 2011 11

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERY • Imbalances in real estate markets: Real estate Figure 1.10. Global Inflation markets are moribund in a number of advanced (Twelve-month change in the consumer price index unless noted economies. Downside risk from a shadow inven- otherwise) tory of homes at risk of foreclosure in the United Inflation is rising everywhere. However, core inflation and wages remain subdued in States is still significant––this is discussed in more advanced economies, held back by high unemployment. In many emerging and depth in the April 2011 Global Financial Stability developing economies, inflation pressures are broadening amid accommodative macroeconomic policies and increasingly binding capacity constraints. Report. In the meantime, new risks are building because of booming real estate markets in emerg- Global Aggregates ing market economies. 10 Headline Inflation Core Inflation 10 • Overheating in emerging market economies: Growth Emerging economies excluding India in these economies could surprise on the upside in 8 Emerging economies 8 Emerging the short term because of relatively loose macro- excluding India economies 6 Emerging 6 economic policies (see below), but medium-term economies 4 World World 4 risks are to the downside. These risks are explored in Box 1.2, which presents an alternative scenario 2 2 to the WEO projections that is based on tighter Advanced economies Advanced economies 0 0 cyclical conditions in emerging market economies than assumed in the WEO projections. Under -2 -2 2002 04 06 08 Feb. 2002 04 06 08 Feb. this scenario, higher interest rates, weaker future 11 11 income growth, and the impact of fiscal adjust- Country Indicators ment correct excesses that have built up during the 5 Advanced Economies: Advanced Economies: Core 5 boom phase but at the price of a global economic Headline Inflation Inflation 4 4 bust, including a large drop in commodity prices. United States1 3 United States1 3 Global imbalances between advanced economies 2 Euro 2 and emerging Asia would widen again under such 1 area Euro area 1 a scenario, while imbalances involving commodity 0 0 exporters would diminish. -1 Japan Japan -1 The most tangible downside risk still arises from -2 -2 tension in the euro area periphery, which may spread -3 -3 to the core European economies. Despite increasing 2002 04 06 08 Feb. 2002 04 06 08 Feb. 11 11 clarity, markets remain apprehensive about the sufficiency of funding available under the European 4 Advanced Economies: Inflation Emerging Economies: Headline 25 Expectations 2 Inflation Financial Stability Facility and European Financial 3 United States 20 Stability Mechanism and the functioning of the Brazil Russia permanent European Stability Mechanism. The 15 2 hollowing out of the traditional investor base for Euro area 10 government bonds in the most vulnerable euro area 1 India 3 5 sovereigns continued as new rules for bondholder 0 bail-ins were announced at the same time that 0 Japan China markets question the sustainability of public debt -1 2002 04 06 08 Mar. 2002 04 06 08 -5 Feb. levels in some economies. Risks are exacerbated by 11 11 continuing weakness among financial institutions in much of Europe, a lack of transparency about Sources: Consensus Economics; Haver Analytics; and IMF staff calculations. 1 Personal consumption expenditure deflator. their exposures, and weak sovereign balance sheets. 2 One-year-ahead Consensus Forecasts. The December values are the average of the Although the periphery accounts for only a small surrounding November and January values. 3 Consumer price index for industrial workers. portion of the euro area’s overall output and trade, substantial financial linkages with core countries,12 International Monetary Fund | April 2011

CHAPTER 1 GLOBAL PROSPECTS AND POLICIESas well as financial spillovers through higher risk Figure 1.11. Measures of Monetary Policy and Liquidityaversion and lower equity prices, could generate in Selected Advanced and Emerging Economiesa significant slowdown in demand. A pessimistic (Percent, unless noted otherwise)scenario created for the January 2011 WEO Update Short-term real interest rates are appropriately low in many advanced economies andsuggests that if these risks materialize, they could not expected to rise much over the coming year. However, interest rates appear lowlower euro area output by 3 percentage points and in many emerging market economies as well. Significant policy rate hikes are generally not expected over the coming year.global output by 1 percentage point relative to the 1,2 Policy Rate Expectations 3,4baseline forecast. 4 Real Short-Term Interest Rates 2.5 (months on x-axis) At the same time, there are some upside risks: 3 2.0• Consumption in advanced economies: Demand for 2 Euro area Europe consumer durables may continue to recover faster 1.5 than expected in advanced economies, as house- 1 United hold saving rates stabilize and fears of job losses Japan Kingdom 1.0 0 recede. This would be both good and bad news: -1 0.5 activity would be stronger, but where house- United States United States hold balance sheets are still weak, vulnerabilities -2 0.0 2000 02 04 06 08 Feb. t t+3 t+6 t + 9 t + 12 would persist and global imbalances would widen 11 again—that is, the sustainability of the recovery 20 Nominal Policy Rates Real Policy Rates2 14 would not improve.• Recovering investment: Investment in machinery 12 16 Latin Latin and equipment may rebound more vigorously, America 5 America5 10 owing to strong corporate profits and balance 12 8 sheets. This has already taken place to some extent Eastern 6 8 in the United States, although the investment-to- Europe 6 Asia 4 GDP ratio remains well below precrisis readings. 4 Asia Eastern 2• Short-term demand buoyancy in emerging and Europe 6 developing economies: Upside surprises in advanced 0 0 2003 04 05 06 07 08 09 Feb. 2003 04 05 06 07 08 09 Feb. economies would add to demand pressures in 11 11 emerging and developing economies while boost- Policy Rates7 12 (percent; deflated by two-year-ahead inflation projections) ing energy prices. In the short term, growth in 10 emerging market economies could also surprise 8 on the upside for domestic reasons. However, over 6 the medium term, the aforementioned downside 4 2 risk of overheating predominates. 0 February 2011 -2 April 2008 Consensus Forecasts short-term interest rate for Feb. 20128 -4Differences in the Pace of Activity Present -6 BR CL CN CO ID IN KR MX MY PE PH PL TH TR TW ZAShort-Term Policy Challenges The conjunctural setting—sobering for advanced Sources: Bloomberg Financial Markets; Consensus Economics; Eurostat; Haver Analytics;economies and positive for emerging and develop- and IMF staff calculations. 1 Three-month treasury bill.ing economies—is creating new tensions, especially 2 Relative to core inflation. 3 Expectations are based on the federal funds rate for the United States, the sterlingin key emerging and developing economies. Rising overnight interbank average rate for the United Kingdom, and the euro interbank offeredcommodity prices and diminishing excess capacity forward rates for Europe; updated April 4, 2011. 4 Dashed lines are from the October 2010 WEO.are pushing up inflation in these economies. Key 5Argentina, Brazil, Chile, Colombia, Mexico, and Peru. 6 Bulgaria, Hungary, Latvia, Lithuania, and Poland.emerging market economies are also experiencing a 7BR: Brazil; CL: Chile; CN: China; CO: Colombia; ID: Indonesia; IN: India; KR: Korea; MX:credit boom. At the same time, authorities are often Mexico; MY: Malaysia; PE: Peru; PH: Philippines; PL: Poland; TH: Thailand; TR: Turkey; TW: Taiwan Province of China; ZA: South Africa.reluctant to tighten macroeconomic policies because 8As of February 2011; overnight interbank rate for Turkey. International Monetary Fund | April 2011 13

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERY Figure 1.12. General Government Fiscal Balances and they fear that growth in advanced economies could Public Debt disappoint, higher domestic interest rates could lead (Percent of GDP unless noted otherwise) to exchange rate overshooting or unmanageable Fiscal deficits and public debt are very high in many advanced economies. Although capital flows, and lower public spending could add policy became much less stimulatory in 2010, real GDP growth picked up, suggesting to pain inflicted by rising food prices. In response, a a handoff from public to private demand. For 2011, fiscal consolidation is expected to be modest in advanced economies. As a result, the adjustment required to achieve number of emerging market economies are resorting prudent debt levels by 2030 remains very large. Fiscal adjustment will be larger in to prudential tightening, and some have adopted economies with high external surpluses than in economies with high deficits, which is consistent with widening global imbalances. capital controls to mitigate potential costs related to overheating. However, insufficient macroeconomic 2 Fiscal Balance Public Debt 120 Emerging and Advanced policy tightening raises the risk of a hard landing. 0 economies 100 developing economies The rise in commodity prices is easier to manage -2 80 for advanced economies. The three main challenges G7 -4 60 facing many of these economies are to preserve or Advanced World -6 economies 40 regain fiscal credibility, repair and reform the finan- World Emerging and -8 developing economies 20 cial sector, and reduce high unemployment. -10 0 Despite these differences, the policy challenges facing 1980 90 2000 10 16 1950 60 70 80 90 2000 10 16 both advanced and emerging and developing economies are tightly linked. Advanced economies’ policy 2 Fiscal Impulse 300 Public Debt, 20161 150 Advanced economies responses, such as easy monetary policy, have spillover 1 Emerging economies 250 125 effects on emerging and developing economies. Con- October 2010 WEO 200 100 versely, the policies adopted by emerging and devel- 0 150 75 oping economies, such as exchange rate policies and -1 100 50 capital controls, are affecting not only the advanced -2 economies but also other emerging and developing 50 25 economies. However, spillovers do not in themselves -3 0 0 2009 10 11 JP2 IT US FR GB ES CA DE indicate that there are fundamental macroeconomic policy conflicts of interest between countries. In14 Required Adjustment 1,3 Structural Fiscal Balance 4 general, stronger and more far-sighted policies would12 Projected adjustment, 3 deliver not only better national outcomes but also bet- 2010–1510 ter global outcomes than projected here. 2 8 1 6 4 0 Advanced Economies Need to Repair Public 2 2011 change -1 and Financial Balance Sheets 2011–16 change 0 -2 JP US GB ES FR CA IT DE Excessive Excessive Aligned 4,7 In many advanced economies, output gaps are still external external large and are projected to close only gradually over surpluses4,5 deficits4,6 the medium term, and unemployment rates remain Sources: IMF, Fiscal Monitor; and IMF staff calculations. 1CA: Canada, DE: Germany, ES: Spain, FR: France, GB: United Kingdom, IT: Italy, JP: stubbornly high. In the United States and the euroJapan, US: United States. area, respectively, unemployment rates are close to 2Left scale for Japan. 3Cyclically adjusted primary balance adjustment needed to bring the debt ratio to 60 9 percent and 10 percent, and output gaps for 2010percent by 2030. For Japan, the scenario assumes a reduction in net debt to 80 percent of are estimated at somewhat less than 5 percent andGDP; this corresponds to a gross debt target of about 200 percent of GDP. 4 Based on the IMF staff’s Consultative Group on Exchange Rate Issues (CGER). CGER 3 percent of potential GDP. Among major advancedeconomies include Argentina, Australia, Brazil, Canada, Chile, China, Colombia, CzechRepublic, euro area, Hungary, India, Indonesia, Israel, Japan, Korea, Malaysia, Mexico, economies, the United States and Spain suffered byPakistan, Poland, Russia, South Africa, Sweden, Switzerland, Thailand, Turkey, United far the largest increases in unemployment relative toKingdom, and United States. For a detailed discussion of the methodology for thecalculation of exchange rates’ over- or undervaluation, see Lee and others (2008). precrisis levels; others saw increases of about 2½ per- 5 These economies account for 18.5 percent of global GDP. 6 These economies account for 27.4 percent of global GDP. centage points or less. Quick reductions in these rates 7 These economies account for 39.2 percent of global GDP. appear unlikely because output gaps are projected to14 International Monetary Fund | April 2011

CHAPTER 1 GLOBAL PROSPECTS AND POLICIESclose only gradually as fiscal policy is tightened andfinancial sector repair occurs over time. Furthermore, Figure 1.13. Risks to the Global Outlookemployment-intensive activities take a long time torecover after banking or housing crises.7 Risks to global growth have receded, as evidenced by the falling dispersion of analysts’ forecasts. Nonetheless, they remain mainly to the downside. For 2012, this reflects mainly concerns about high oil prices.Monetary Policy Can Remain Accommodative in Most Prospects for World GDP Growth1Economies 7 (percent change) 6 Many advanced economy central banks can 5accommodate hikes in food and energy prices 4mainly because the weight of food and energy in 3the consumer basket is relatively small, people have Baseline forecast 50 percent confidence interval 2learned from experience that such hikes do not set 70 percent confidence interval 1off a cycle of inflation, and excess capacity will exert 90 percent confidence interval 0downward pressure on wages. Moreover, in major -1economies bank credit is still very sluggish. The 2008 09 10 11 12Federal Reserve and Bank of Japan are forecast to Balance of Risks Associated with Selected Risk Factors 2 0.4keep their interest rates very low during 2011, in 0.2view of the subdued wage claims and large outputgaps (see Figure 1.11, top panel). The European 0.0Central Bank (ECB) is expected to raise rates as it -0.2sees growing upside risks to price stability, but it hasprolonged unconventional support in recognition of Balance of risks for -0.4 2011 (October 2010 WEO)still-high financial risks. Economic conditions and 2011 (current WEO) -0.6underlying price pressures are somewhat stronger in 2012 (current WEO) -0.8other advanced economies, and these central banks Term spread S&P 500 Inflation risks Oil market riskshave already raised rates (for example, Australia, 70 Dispersion of Forecasts and Implied Volatility 0.8Canada, Israel, Korea, Norway, Sweden). Most of 60 0.7their policy rates remain accommodative, in a 1 to 50 0.6 GDP 33 percent range, and they will have to do more as (right scale) VIX 4 0.5 40 (left scale)unemployment rates fall and food and energy prices 0.4put pressure on wages. In this set of economies, mar- 30 0.3kets generally expect hikes on the order of ½ to 1½ 20 0.2percentage points over the coming year.8 10 Term spread 5 0.1 (right scale) However, even advanced economy central banks 0 0.0 2002 04 06 08 10 Mar.with well-established inflation-targeting regimes 11may struggle to protect their credibility when hit Sources: Bloomberg Financial Markets; Chicago Board Options Exchange; Consensus Economics; and IMF staff estimates.with a succession of one-time price shocks or trend 1The fan chart shows the uncertainty around the WEO central forecast with 50, 70, and 90increases in the prices of specific items in consumer percent probability intervals. As shown, the 70 percent confidence interval includes the 50 percent interval, and the 90 percent confidence interval includes the 50 and 70 percentbaskets. The Bank of England, for example, has seen intervals. See Appendix 1.2 in the April 2009 WEO for details. 2 Bars depict the coefficient of skewness expressed in units of the underlying variables. The values for inflation risks and oil market risks are entered with the opposite sign, since they represent downside risks to growth. The balance of risk for 2012 is not available for the 7See Chapter 3 of the April 2010 World Economic Outlook and S&P 500 index and the term spread. 3 The series measures the dispersion of GDP forecasts for the G7 economies (Canada,Dowling, Estevão, and Tsounta (2010). 8Another problem faced by some of these economies after the France, Germany, Italy, Japan, United Kingdom, United States), Brazil, China, India, and Mexico.crisis has been accelerating real estate prices in the face of low 4 VIX: Chicago Board Options Exchange Market Volatility Index.interest rates––as in a number of emerging market economies 5 The series measures the dispersion of term spreads implicit in interest rate forecasts forthe authorities are resorting to macroprudential measures to slow Germany, Japan, the United Kingdom, and the United States.down these price rises (for example, Canada, Hong Kong SAR). International Monetary Fund | April 2011 15

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERY inflation running above its 2 percent midpoint target investment, and potential output. In short, as long for much of the period since 2005, reflecting food as advanced economies implement policies that and energy price increases, value-added tax hikes, foster their own sustained recovery, emerging and and depreciation of the currency. CPI inflation is developing economies will benefit. To the extent now about 4½ percent, although wage inflation that policies in advanced economies disappoint, seems well contained. Households’ inflation expecta- spillovers from fiscal (and financial) policy short- tions are creeping up, but other measures of inflation comings are likely to be much worse than from expectations have changed little over the past year. monetary shortcomings. This experience suggests that central bankers will need to communicate very clearly how they intend to respond to one-time or relative price shocks. Much Stronger Efforts Are Needed to Maintain or The objective should be to accommodate foreign Rebuild Fiscal Credibility price inflation as long as it does not pose significant Preserving or regaining fiscal credibility in the face threats to domestic price inflation. of high public deficits and debt presents a major chal- There is no need to actively unwind unconven- lenge for many advanced economies. Most of these tional measures, at least not in the near term, as economies are planning to tighten fiscal policy signifi- fears that they will stoke inflation pressure are mis- cantly in 2011, but the pace of fiscal consolidation in placed. As discussed in previous issues of the World 2011 will be far below earlier estimates––the October Economic Outlook, to the extent that these measures 2010 World Economic Outlook foresaw a reduction inject liquidity, this can be reabsorbed. Unconven- in structural deficits of almost 1 percent of GDP, tional measures fall into two categories: whereas current WEO projections are for a reduc- • Quantitative easing—that is, purchases of govern- tion of only ¼ percent of GDP (Figure 1.12, middle ment bonds to lower long-term interest rates: In panel). This reflects mainly a major change in the the United States and the United Kingdom, new policy stance of the United States, where the struc- programs for purchases appear unnecessary, given tural deficit is now projected to widen by 0.6 percent current prospects for activity and developments of GDP rather than contract by 0.9 percent of GDP in inflation expectations. For Japan, the jury is in 2011. Its economy appears sufficiently strong to still out: core inflation is recovering gradually but withstand modest consolidation. Furthermore, the still running close to zero, and deflation therefore short-term impact of the stimulus deployed in the appears far from vanquished. United States on jobs and growth is likely to be low • Qualitative easing—that is, measures to support relative to its cost. Recent measures to trim discretion- the functioning of specific markets or ensure ary spending will reduce the federal deficit for fiscal availability of sufficient liquidity: Many of these year 2011 below the projection recently released in measures have already unwound naturally. In the president’s draft fiscal year 2012 budget. However, some economies and some markets, notably the more sizable reductions in medium-term deficits are euro area, they need to be maintained until there needed and will require broader reforms, including to is a lasting improvement in liquidity. However, Social Security and taxation. In Japan, structural fiscal the authorities must ensure that these measures do tightening will also be more gradual than expected in not postpone fundamental bank restructuring. the October 2010 WEO projections, due to a new Available evidence suggests that as long as stimulus program and support for reconstruction after monetary policy successfully stabilizes output in the earthquake. Once reconstruction efforts are under advanced economies, spillovers to emerging and way and the size of the damage is better understood, developing economies will not be detrimental attention should turn to linking reconstruction spend- (Box 1.3). By contrast, concerns about detrimen- ing to a clear fiscal strategy for bringing down the tal spillovers from insufficiently ambitious fis- public debt ratio over the medium term. cal adjustment in advanced economies are quite Elsewhere, fiscal policy is projected to be appro- relevant, given the effects on global interest rates, priately contractionary. In the euro area, structural16 International Monetary Fund | April 2011

CHAPTER 1 GLOBAL PROSPECTS AND POLICIESdeficits are projected to fall by about 1 percent of ing France, Spain, and—to a much lesser extent—GDP; in the United Kingdom, cutbacks are larger, Italy to identify new measures.reaching 1¾ percent of GDP. This is in line with Little progress has been made in many economiesprevious budgetary plans. in specifying measures to redress remaining medium- Some economies under extreme pressure from term imbalances, and so advanced economies willmarkets have embarked on ambitious medium-term still have to enact very large fiscal adjustments inreforms. Many other advanced economies have order to reduce their general government gross-debt-defined adjustment strategies in broad terms and to-GDP ratio to a level of 60 percent by 2030 (Fig-have begun to implement them. However, with the ure 1.12, bottom panel).12 According to a scenarioexception of those that are front-loading their adjust- developed in the IMF’s April 2011 Fiscal Monitor,ment and those with strong fiscal frameworks (for the required adjustments amount to more thanexample, Canada, Germany, United Kingdom), these 10 percent of GDP for Japan and the United States;economies have generally not explained the measures 5 to 10 percent of GDP for France, Spain, and theunderlying their adjustment plans in enough detail.9 United Kingdom; and 3 to 4 percent of GDP forIn this regard, only limited progress has been made Canada, Germany, and Italy. Among the smaller,over the past six months, which is not to deny the vulnerable economies, the required adjustments liecontinuation of discussion and debate. Hence, projec- between about 6 percent of GDP for Portugal andtions for structural fiscal balances over the medium more than 10 percent of GDP for Greece and Ire-term are largely unchanged for the major advanced land. These countries have, in fact, recently enactedeconomies relative to those of the October 2010 stringent measures in the face of increased marketWorld Economic Outlook. Most advanced G20 econo- pressures (see the November 2010 Fiscal Monitor).mies are still projected to meet their target of halving The absence of well-specified medium-term plansdeficits by 2013 relative to 2010.10 The United States in several economies raises increasingly seriousremains committed to achieving this target. Because concerns, particularly about the United States. Asof the loosening of fiscal policy for 2011, meeting activity continues to pick up, large sovereign fundingit now requires about 5 percent of GDP cumula- requirements will put upward pressure on interesttive structural adjustment for the federal government rates, slowing the recovery of the private sector andduring fiscal years 2012–13, which may be difficult lowering potential output. This could cause abruptto achieve.11 Furthermore, under IMF staff estimates, increases in interest rates in the United States (fromthe U.S. gross-debt-to-GDP ratio is not projected to especially low levels) that could destabilize globalstabilize over the forecast horizon and would exceed bond markets, with particularly deleterious effects on110 percent by 2016, compared with less than 90 emerging market economies (Chapter 4). Gradualpercent in the euro area and almost 250 percent in increases would slow investment and potentialJapan (see Figure 1.12, middle panel). growth in advanced as well as emerging and develop- Among the major euro area countries, all are ing economies. While the immediate concern incommitted to reducing deficits to below 3 percent Japan should be to support reconstruction, measuresof GDP by 2013. However, based on currently that support a reduction of its high public debt ratioannounced plans and WEO growth projections, only over the medium term need to be specified to main-Germany is forecast to achieve this objective––leav- tain the strong confidence of its investor base. More generally, as the share of retirees begins to 9For a detailed assessment of medium-term fiscal plans of 25 grow more rapidly over the coming decade, fun-economies, see Bornhorst and others (2010). 10In its fiscal strategy of June 2010, Japan committed to halv- damental reform of entitlement programs, whiching the government primary deficit in percent of GDP by fiscal is indispensable to attaining sustainable publicyear 2015 and achieving a primary surplus by fiscal year 2020 atthe latest. 12Similar results are described in the October 2010 World 11For the general government, the reduction in the structural Economic Outlook. For Japan, the scenario assumes a reduction indeficit would amount to about 4 percent of GDP in calendar net debt to 80 percent of GDP; this corresponds to a gross debtyears 2012–13. target of about 200 percent of GDP. International Monetary Fund | April 2011 17

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERY finances, may become even harder to achieve. An quick solutions, but strong measures are necessary increasingly fractionalized political sphere in a to nurture adjustment and anchor expectations and number of advanced economies, including Japan and thereby lower the probability of panic scenarios. the United States, poses additional fiscal risks, as is In the meantime, financial repair and reform well known from the political economy literature on need to move forward on a variety of other fronts. fiscal policy.13 The challenges are discussed in depth in the April 2011 Global Financial Stability Report. In the United States, programs are needed to facilitate Financial Sector Repair Must Be Accelerated principal write-downs of distressed first mortgages The main short-term challenges relate to instabil- and second liens to clear out a large shadow inven- ity within the euro area. Policymakers should take tory of nonperforming mortgages, including for advantage of the moderately improved conditions to households facing negative equity in their homes, make real progress in addressing them. At the euro and avoid unnecessary foreclosures. This would area level, what is needed is sufficient, low-cost, and pave the way for further repair and reform of flexible funding for countries that are facing market mortgage credit and securitization markets. More pressures and need external help to support adjust- generally, in the United States and elsewhere, the ment. In addition, major reforms to euro area eco- postcrisis supervisory and regulatory architecture nomic governance are necessary to help prevent the is still very much a work in progress. The shadow recurrence of such turmoil in the future. Significant banking system and institutions that are too large, progress was made on both fronts during March or too complex, to fail pose problems that have 2011 but important issues remain to be addressed. not yet been fully addressed. Furthermore, stronger In the meantime, the ECB should continue to supervision and resolution frameworks are needed ensure orderly conditions in funding markets and for cross-border financial institutions; this will help prevent excessive volatility in sovereign debt require significantly enhanced international coop- markets. The priorities for countries under pressure eration, including in day-to-day supervision. are fiscal adjustment and entitlement and structural reform. Also important is a new round of strong, broad, and transparent stress tests, backed by cred- Emerging Market Economies Need to Guard ible restructuring and recapitalization programs, to against Overheating and Credit Booms strengthen confidence in euro area banking systems. In many emerging and developing economies, This is essential to break the negative feedback loop output is already above precrisis trends, suggesting between sovereign and banking sector instability and that recovery is complete and expansion under way. to rebuild competitiveness. Output of all emerging and developing economies There has been major progress over the past year stands about 2½ percent above precrisis (1997– in addressing euro area challenges (Chapter 2). 2006) trends (Figure 1.14, bottom panel). In many Notwithstanding improving conditions and con- of the major emerging market economies outside fidence, even after all these and further efforts are central and eastern Europe and the CIS, unem- deployed, there is likely to be continued uncertainty ployment rates are below precrisis levels. Headline while markets monitor the implementation of the inflation is now exceeding 6 percent, up from 5¾ new measures and refine their views on public and percent in January 2010—excluding India, the external debt sustainability. In short, there are no increase in inflation rate amounts to 1¼ percentage points.14 Over the same period, core inflation 13Roubini and Sachs (1989), Roubini and others (1989), increased from about 2 percent to 3¾ percent, Alesina and Drazen (1991), and Poterba (1994) present empirical evidence suggesting that economic shocks prompt action but 14In India, the CPI for industrial workers suggests that infla- that more fragmented governments have typically postponed tion fell from about 16 percent in January 2010 to less than 10 fiscal adjustments. For a general discussion of the role of political percent in December 2010, helped by less food price inflation on economy in distorting fiscal policy, see Alesina and Perotti (1995). account of postdrought recovery in agricultural output. Nonethe-18 International Monetary Fund | April 2011

CHAPTER 1 GLOBAL PROSPECTS AND POLICIESsuggesting that inflation pressure is broadening. Figure 1.14. Emerging TensionsIn a number of the larger economies, headlineinflation is running close to or above central bank Commodity prices have risen fast, and capacity constraints are appearing in a growing number of emerging market economies. Terms of trade of emerging andtargets (Figure 1.15, left panel). Furthermore, some developing economies have improved again, fueling domestic demand in commodityeconomies are experiencing a credit boom. exporters. The high share of food and fuel in consumer baskets in these countries means their economies are particularly sensitive to food and fuel price shocks.• Output of developing Asia and Latin America stands, respectively, about 7 percent and 2 percent Real Commodity Prices Global Food Commodity 500 (1995 = 100) 300 40 Markets—Stocks and Prices 2 200 above 1997–2006 trends. Some major economies Food price index Grain inventories 180 show clear evidence of appreciable positive gaps. In (2005 = 100, 400 250 35 (percent, left Oil prices1 right scale) Argentina and Indonesia, output is about 13 to 15 (left scale) scale) 160 30 300 200 140 percent above precrisis trends; in Brazil and India, Metals 25 (right scale) it is about 7 percent higher. WEO projections 200 150 120 20 assume that potential growth rates in these econo- 100 100 100 15 mies have recently been higher than 1997–2006 Gold 80 (left scale) averages: accordingly, they place estimates of output 0 50 10 60 1980 90 2000 10 16 1991 96 2001 06 11 gaps for these countries generally in the zero to 1½ percent positive range. In China, output is also Share of Food and Fuel in CPI Basket 3 Terms of Trade in Emerging 120 appreciably above precrisis trends, although much PH and Developing Economies ID (2000 = 100) larger investment in productive capacity than in the 115 PE other economies has limited constraints on produc- CO MY 110 tion. In many of these economies, both headline MX and core inflation either are rising from low levels IN 105 PL or are fairly high already. BR 100• Output in sub-Saharan Africa and the Middle CL ZA East and North Africa has broadly returned to 95 0 10 20 30 40 50 60 2000 05 10 15 16 precrisis trends. Some of these economies are already experiencing higher inflation; pressures Real GDP in 2010 in Percent of Precrisis Trend4 120 will build, not least owing to accelerating activity 115 in commodity exporters. 110• In Mexico, Russia, and Turkey, output is appre- 105 ciably below precrisis trends. WEO projections 100 95 suggest that much of the output lost relative to 90 1997–2006 trends has been lost permanently and 85 therefore point to much smaller negative or clos- 80 ing output gaps; for Turkey, they even point to a IT ID FR AE DE JP AR 5 EM ZA TR CA KR BR CN RU SA IN US AU GB CIS MX CEE SSA LAC DA World MENA positive output gap. At the same time, a number of major emerging Sources: U.S. Department of Agriculture (USDA); and IMF staff estimates. 1Simple average of spot prices of U.K. Brent, Dubai Fateh, and West Texas Intermediatemarket economies and a few advanced economies crude oil. 2 Global end-year inventories as a percent of consumption, with USDA projections forwith close links to them feature very buoyant credit 2011.and asset price growth (Figure 1.16, top panel). This 3 CL: Chile; CO: Colombia; MY: Malaysia; PE: Peru; PH: Philippines; PL: Poland. 4 Precrisis trend obtained by extrapolating 1996–2006 real GDP growth. AR: Argentina;set of economies accounts for about one-quarter of AE: advanced economies; AU: Australia; BR: Brazil; CA: Canada; CEE: central and easternglobal GDP in purchasing-power-parity terms or Europe; CIS: Commonwealth of Independent States; CN: China; DA: developing Asia; DE: Germany; EM: emerging economies; FR: France; GB: United Kingdom; ID: Indonesia; IN:about half of emerging and developing economy India; IT: Italy; JP: Japan; KR: Korea; LAC: Latin America and the Caribbean; MENA: Middle East and North Africa; MX: Mexico; RU: Russia; SA: Saudi Arabia; SSA: sub-Saharanoutput. The issue is whether they are experiencing Africa; TR: Turkey; US: United States; ZA: South Africa. 5 Private analysts are of the view that real GDP growth was significantly lower than the official estimates in 2008 and 2009, although the discrepancy between private andless, inflation has remained stubbornly high and well above the official estimates of real GDP growth has narrowed in 2010. This may affect the estimates of output relative to trend.central bank’s stated objective. International Monetary Fund | April 2011 19

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERYFigure 1.15. Overheating Indicators and Capital InflowsAmong G20 economies, a growing number of emerging market economies and a few advanced economies either are close to or are already overheating. Macroeconomic policies inthese economies are still accommodative. Capital inflows have also rebounded, exceeding precrisis averages in a number of emerging market economies. With limited recourse tocapital controls, these economies have relied widely on prudential measures. Overheating Indicators—G201 Policy Responses to Capital Flows—Selected Economies7 Output Macroprudential Summary relative Output Unem- Inflation Fiscal Real interest Capital Over- FX over- Domestic Currency- Capital to trend 2 gap 3 ployment 4 balance 5 rate 6 flows8 heating valuation 9 related controls Argentina Indonesia Brazil Thailand10 Brazil Indonesia Colombia India Malaysia China Mexico Korea India Saudi Arabia Poland Australia Chile Germany Peru South Africa10 South Africa Hong Kong SAR Turkey TurkeyUnited Kingdom China Canada Philippines10 Japan Israel Mexico Romania Russia Russia Czech Republic France Korea Italy Argentina United States Hungary Sources: Haver Analytics; and IMF staff calculations. 1For each indicator, except inflation, economies are assigned “traffic lights” based on where they stand relative to other G20 economies. For inflation, economies with an inflation-targetingregime are assigned a red light if inflation is above the upper bound of their target and a yellow light if inflation is in the upper half of the target range; for nontargeters, a red light denoteshistorically high inflation, and a yellow light denotes rising inflation (above historically moderate levels). Individual indicators vary for idiosyncratic reasons (e.g., South Africa has a red light forunemployment because the rate is currently lower than precrisis levels, even though unemployment is still above 20 percent). For this reason, a summary column is included, which shows theaverage across individual indicators; economies are ranked according to this average. 2Output above the precrisis trend is indicated by a red light. Output less than 95 percent of the trend is indicated by a green light. 3An output gap above zero is indicated by a red light. A gap below 2 percent is indicated by a green light. 4The unemployment indicator is based on a comparison of current unemployment levels to average precrisis levels during 2002–07. 5Arrows in the fiscal balance column represent the forecast change in the structural balance as a percent of GDP over the period 2010–11. An increase of more than 0.5 percent of GDP isindicated by an up arrow; a decrease of more than 0.5 percent of GDP is indicated by a down arrow. 6Real policy interest rates below zero are identified by a down arrow; real interest rates above 3 percent are identified by an up arrow. 7For the purposes of this figure, policy responses are divided into three categories: (1) domestically focused macroprudential measures are those affecting the domestic activities of banks, suchas loan-to-valuation ratio limits; (2) currency-related measures aim to limit institutions’ and residents’ exposure to currency fluctuations; and (3) capital controls are measures that distinguishbetween residents and nonresidents. 8Gross capital flows over the past year compared with the average during 2000–07. Current flows above 150 percent of the average are assigned a red light; a yellow light denotes flows above100 percent. Economies are ranked based on this ratio. 9Economies with exchange rates higher than warranted by medium-term fundamentals are assigned a red light. Economies with lower-than-warranted exchange rates are assigned a green light.FX = foreign exchange. 10 Has relaxed capital outflow restrictions. the kind of credit boom that inevitably ends with a adopted various macroprudential measures to rein bust. Evidence is not reassuring in this regard. in excesses and stand ready to do more. In the case • Credit and asset price behavior is disconcerting of China, the authorities have managed credit, in China and Hong Kong SAR, showing boom- increased reserve requirements, and raised interest like dimensions (Figure 1.16, middle and bottom rates several times. Nonetheless, in both economies panels).15 In both economies, the authorities have credit growth remains high compared with the run- ups to previous credit booms and busts, and there 15To identify a “credit boom,” real credit and credit-to-GDP ratios are detrended with the help of a Hodrick-Prescott ﬁlter, in exists when the cyclical component of credit exceeds the average line with the methods adopted by Mendoza and Terrones (2008) historical cyclical component by 1.75 times the standard devia- and Gourinchas, Valdés, and Landerretche (2001). A credit boom tions of the credit variable.20 International Monetary Fund | April 2011

CHAPTER 1 GLOBAL PROSPECTS AND POLICIES are mounting concerns about the potential for steep Figure 1.16. Emerging Market Economies with Strong corrections in property prices and their implications. Credit Expansion1• Brazil, Colombia, India, Indonesia, and Turkey A number of major emerging market economies (EMEs) and a few advanced have experienced a noticeable pickup in real credit economies with close links to these economies feature very buoyant credit and asset growth, generally close to or well into a 10 to price growth. The EMEs with such conditions account for about one-quarter of global GDP in purchasing-power-parity terms, or about half of EME output. Furthermore, 20 percent range (more in the case of Turkey). these economies have been experiencing relatively strong credit growth for a number Over the past five years, credit almost doubled of years, raising concerns about the quality of this credit. in real per capita terms in these economies. Such Real Credit Growth expansions are close to those experienced before (year-over-year percent change) HK CN 2 IN MY TR ZA previous credit booms and busts (see Figure 1.16, BR NG2 ID CO middle and bottom panels).16 Other telltale signs 60 120 40 of an emerging credit boom include accelerat- 50 100 30 ing inflation and rapid increases in the prices of 40 80 property. In India, credit growth has just begun 30 60 20 to increase again, after a boom through much of 20 40 10 2007 was followed by a sharp slowdown during 10 20 2008–09. Nonetheless, from a five-year perspec- 0 0 0 tive, per capita real credit growth has been very -10 -20 buoyant, with much flowing into real estate and -20 2006 07 08 09 -40 Dec. 2006 07 08 09 -10 Dec. large infrastructure projects. Similar consider- 10 10 ations apply to Peru, where credit is also gener- Per Capita Real Credit (percent change over five years) ated outside the banking system.17 Current (2005–10) Previous (label indicates year of prior peak)• Conditions are less buoyant in Malaysia and Sin- 160 08 320 gapore. Real credit growth in these economies has 140 97 280 exceeded 10 percent on only a few occasions over 120 99 95 08 98 240 07 the past five years. Both raw and cyclically adjusted 76 84 100 200 credit indicators suggest that conditions do not 80 97 97 08 160 07 match those seen just ahead of previous busts. 60 07 120 However, their real exchange rates have appreciated 40 98 80 significantly and asset markets have boomed. 20 40 0 0 CN BR TR CO IN ID CL HK JO MY ZA SG NG2 VE2 PE2Macroeconomic and Prudential Policies Need to Credit/GDPTighten (change over five years; percentage points) Current (2005–10) Previous (label indicates year of prior peak) There is a risk that these boom-like conditions 35 97 70may intensify over the coming year. Inﬂation pres- 30 97 60sure is likely to build further in response to growing 25 03 94 08 08 01 07 50 20 76 40capacity constraints, with large food and energy 08 98 15 06 30price increases––which weigh heavily in consump- 98 07 10 20tion baskets––motivating demands for higher wages. 5 98 10 0 0 16The -5 -10 increase in credit has been ongoing for some time.Because the detrending methods cited previously remove much -10 -20 CN BR TR NG CL SG CO IN PE VE ID JO HK 2 MY2 ZA 2of this increase, these countries do not meet the necessary criteriaunder a strict deﬁnition of a credit boom. Sources: IMF, International Financial Statistics; and IMF staff calculations. 1 BR: Brazil; CL: Chile; CN: China; CO: Colombia; HK: Hong Kong SAR; ID: Indonesia; IN: 17In Nigeria, a number of banks were found to be insolvent or India; JO: Jordan; MY: Malaysia; NG: Nigeria; PE: Peru; SG: Singapore; TR: Turkey; VE:undercapitalized in 2009, following a credit boom in the preced- Venezuela; ZA: South Africa.ing years. 2 Right scale. International Monetary Fund | April 2011 21

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERY Real interest rates are still low. Fiscal policies are boost, current projections are for a limited decline still much more accommodative than before the in budget deficits of emerging and developing crisis, and public expenditures may rise on account economies, by about 1½ percentage points of of greater outlays for food subsidies. Households GDP in 2011 (Figure 1.12, top panel) and ½ are becoming increasingly leveraged, with rapid percentage point in 2012. The deficit would still consumer credit growth adding to rapid mortgage reach about 1 percent of GDP in 2012, even credit growth. And demand for exports is likely to though output growth is expected to be above pick up as durables consumption and investment in precrisis trend. During 2006–08, in contrast, bud- advanced economies recover further. gets in these economies were in surplus. Although robust output growth is expected to lower the Food and energy prices pose significant risks of debt-to-GDP ratio, a number of emerging market second-round effects economies with high public debt should take The risk that food and energy price increases advantage of strong activity and terms-of-trade- will start an inflationary spiral is much greater related revenues to rebuild fiscal room for policy in emerging and developing economies than in maneuvering. advanced economies. Households typically spend large shares of their incomes on food and energy Policies need to tighten to varying degrees (Figure 1.14, middle panel). In addition, excess Many emerging market economies will need to capacity has generally been eroded or is erod- tighten policies to lower the risk of a hard landing fast, and monetary authorities are, to varying ing. Requirements differ according to cyclical and degrees, still building their credibility. Food price external positions, and Chapter 2 presents more shocks have had an especially severe impact on the detailed assessments for the various regions. In most poor, exerting political pressure for wage hikes and economies, further removal of monetary accom- a more accommodative fiscal policy stance––this modation appears indispensable, as does prudential should be met with well-targeted social support tightening to rein in rapid growth in real estate and programs. Furthermore, oil prices may well con- some other sectors. Economies with high public debt tinue to surprise on the upside. should take advantage of strong cyclical conditions to improve their public balance sheets (for example, Policy interest rates appear too low Brazil, India). Furthermore, in most economies, In many emerging market economies, monetary some appreciation of the exchange rate is called for conditions appear very accommodative (Figure 1.11, because of either cyclically large current account sur- middle panel). A number of these economies have pluses (for example, China), terms-of-trade improve- already hiked policy rates (for example, Brazil, China, ments, or greater resilience to shocks. In short, India, Indonesia, Malaysia, Peru, Poland, Russia, policies required to achieve internal and external Thailand, Uruguay), increased cash reserve require- balance go in broadly the same direction. ments (for example, China, India, Indonesia, Russia, A number of emerging market economies have Turkey), or restrained credit growth (for example, seen a historically sharp turnaround in capital flows China). However, real interest rates remain far below following the crisis. Once U.S. policy tighten- precrisis levels in many of these economies, and the ing begins, flows could slow abruptly. This is an extent of expected tightening seems limited relative to additional reason for emerging market economies what is needed (Figure 1.11, bottom panel). to ensure that their domestic policies are suitably countercyclical and that banking regulation and Fiscal policy seems too accommodative, given the supervision are well targeted. Provided appropriate strength of activity macroeconomic and prudential policies are in place, Although rising commodity and asset prices capital controls can be helpful in limiting damage have given government revenues an unexpected caused by volatile capital flows. In fact, when inflows22 International Monetary Fund | April 2011

CHAPTER 1 GLOBAL PROSPECTS AND POLICIESbypass regulated financial institutions and lead to Figure 1.17. Global Imbalancesvulnerability on nonfinancial entities’ balance sheets Global imbalances are projected to widen again over the medium term because(for example, in the case of direct borrowing from domestic demand growth in economies with large surpluses is not expected to beabroad), capital controls may be the only instrument higher than before the crisis. Demand growth in deficit economies is not expected to be much lower, as significant fiscal adjustment has yet to be specified. Reserveavailable to the authorities in the short term. How- accumulation in economies with excessive current account surpluses has dwarfedever, the effectiveness of capital controls beyond the private capital inflows, motivated primarily by concerns about competitiveness. Exchange rates of emerging economies with deficits have appreciatedshort term remains in question, and their benefits disproportionately. The IMF staffs assessment of the valuation of real exchangeshould be weighed against likely costs, including rates has remained broadly unchanged relative to October 2010, with the U.S. dollar strong and Asian currencies (other than the yen) undervalued relative tomultilateral disruptions. As Chapter 4 argues, over medium-term fundamentals.the medium term, deeper and better supervised and Global Imbalances1regulated financial and product markets are criti- (percent of world GDP) 4 DEU+JPN CHN+EMA 3cal for containing vulnerabilities related to volatile OCADC ROW OIL US 2capital flows. 1 In economies where real exchange rate overshooting 0relative to medium-term fundamentals exceeds what -1can be justified by their cyclically more advanced -2 Discrepancypositions posing serious concerns, and where further -3 1996 98 2000 02 04 06 08 10 12 14 16accumulation of reserves seems undesirable, measures 12 Total Domestic Demand Net Financial Flows, 2008–106 1800to curb capital inflows can complement macroeco- (percent) (billions of U.S. dollars) 1600nomic and prudential policies. However, policymak- 9 Average growth, 2003–07 Private financial 1400 Average growth, 2011–16 flows 1200ers need to bear in mind that such measures are not Current account 1000substitutes for general macroeconomic tightening. 6 Change in reserves 800 October 2010 WEO 600A reading of what emerging market economies have 400 3 200done recently suggests that recourse to capital controls 0has been limited; where they have been adopted, fiscal 0 -200 Excessive Excessive Aligned 2,5 Asia MENA LACpolicy has often been tightened, but sometimes not external external surpluses2,3 deficits2,4by enough to control growing pressure on real interestrates and capacity constraints (see Figure 1.15). Real Effective Exchange Rates in Real Effective Exchange 24 20 Emerging Economies7 Rate Assessment 21 15 (percent change from June 2007 18 to February 2011) 10 15 5Global Demand Rebalancing Is Not 12 0Progressing 9 -5 6 -10 Oct. 2010 Previous issues of the World Economic Outlook 3 Current -15underscored the importance of global demand 0 Excessive Excessive Aligned 2,5 United Japan Euro Asia Latin -20rebalancing for sustained, healthy recovery, with an external external States area America surpluses2,3 deficits 2,4increase in net exports in deficit economies and a Sources: Federal Reserve; and IMF staff estimates.decrease in net exports in surplus economies, notably 1CHN+EMA: China, Hong Kong SAR, Indonesia, Korea, Malaysia, Philippines, Singapore,in emerging Asia. The two interact in strong ways, as Taiwan Province of China, and Thailand; DEU+JPN: Germany and Japan; OCADC: Bulgaria, Croatia, Czech Republic, Estonia, Greece, Hungary, Ireland, Latvia, Lithuania, Poland,increased net exports in advanced economies offset Portugal, Romania, Slovak Republic, Slovenia, Spain, Turkey, and United Kingdom; OIL: oil exporters; ROW: rest of the world; US: United States.the loss of demand implied by fiscal consolidation. 2Based on the IMF staff’s Consultative Group on Exchange Rate Issues (CGER). CGERCapital flows are spurring the reallocation of global countries include Argentina, Australia, Brazil, Canada, Chile, China, Colombia, Czech Republic, euro area, Hungary, India, Indonesia, Israel, Japan, Korea, Malaysia, Mexico,demand toward emerging market economies. How- Pakistan, Poland, Russia, South Africa, Sweden, Switzerland, Thailand, Turkey, United Kingdom, and United States. For a detailed discussion of the methodology for theever, a disproportionate burden of demand rebalanc- calculation of exchange rates’ over- or undervaluation, see Lee and others (2008).ing since the beginning of the crisis has been borne 3These economies account for 18.5 percent of global GDP. 4These economies account for 27.4 percent of global GDP.by economies that do not have large current account 5These economies account for 39.2 percent of global GDP. 6Asia: developing Asia; MENA: Middle East and North Africa; LAC: Latin America and thesurpluses but attract flows because of the openness Caribbean. 7Emerging CGER economies only. International Monetary Fund | April 2011 23

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERYFigure 1.18. External Developments and depth of their capital markets (Figure 1.17, bot-(Index, 2000 = 100; three-month moving average unless noted otherwise) tom panel). Current account balances of key surplusAfter depreciating significantly, the euro has regained some strength lately, while the economies—for example, China, Japan, and oilU.S. dollar weakened modestly. The yen has continued to appreciate while the exporters—have receded, as have those of deficitrenminbi has moved broadly sideways in real effective terms. Currencies of mostother emerging economies have tended to appreciate. International reserves are now economies—for example, the United States, Spain,higher than before the crisis in all emerging and developing economy regions. and eastern Europe (Figure 1.17, top panel). Major Currencies However, this has taken place mainly via declining demand growth in deficit economies rather than150 Nominal Effective Exchange Real Effective Exchange Rate 140 Rate stronger demand growth in surplus economies.18 It140 Euro area 130 Euro area reflects both structural factors (for example, low-130 120 ered expectations about future incomes in deficit120 United 110 States China economies; the appreciation of the yen) and cyclical110 100 China factors (for example, the depressed state of demand100 90 for investment goods and consumer durables in 90 80 Japan deficit economies and lower prices for commodity- 80 Japan United 70 States exporting surplus economies). Although temporary 70 60 fiscal stimulus in China and other surplus economies 2000 02 04 06 08 Mar. 2000 02 04 06 08 Mar. 11 11 has helped, sustained, positive rebalancing––acceler- Emerging and Developing Economies ated domestic demand in surplus economies relative120 Nominal Effective Exchange Real Effective Exchange Rate 140 to precrisis trends––has played only a modest role Rate Emerging110 Middle East and Europe 4 130 (Figure 1.17, middle panel). Since publication of the North Africa1100 120 October 2010 World Economic Outlook, external sur- Africa 2 90 Africa2 110 plus economies have made little additional progress Asia3 in rebalancing demand. 80 100 Asia3 There has been significant realignment of real 70 90 effective exchange rates among advanced economies 60 Emerging Latin Middle East Latin and North Africa1 80 relative to precrisis levels but only limited realign- Europe 4 America5 America5 50 Mar. 70 ment in emerging market economies with large 2000 02 04 06 08 2000 02 04 06 08 Mar. 11 11 surpluses (Figure 1.18). This has created tensions. 24 Current Account Positions6 International Reserves6 1200 Emerging market economies with flexible exchange (percent of GDP) 1100 rates, open capital accounts, and relatively deep mar- 20 Asia Middle East and 1000 16 North Africa1 900 kets have seen large capital inflows that have pushed Middle East and 12 Sub-Saharan North Africa1 800 up their exchange rates, in some cases into overvalu- Africa Latin 700 8 America Emerging ation territory (for example, Latin America). Others 600 4 Asia Europe4 500 with managed exchange rates (for example, most of Latin America 400 emerging Asia) are reluctant to allow revaluation as 0 300 Emerging 200 long as systemic surplus economies are not moving -4 Europe4 100 decisively. -8 2000 02 04 06 08 10 2000 02 04 06 08 Dec. • Among advanced economies, the appreciation of 10 the yen and the depreciation of sterling by more Sources: IMF, International Financial Statistics; and IMF staff calculations. 1Bahrain, Djibouti, Egypt, Islamic Republic of Iran, Jordan, Kuwait, Lebanon, Libya, than 20 percent in real effective terms are most Oman, Qatar, Saudi Arabia, Sudan, Syrian Arab Republic, United Arab Emirates, and Republic of Yemen. noteworthy. Official intervention recently helped 2Botswana, Burkina Faso, Cameroon, Chad, Republic of Congo, Côte d’Ivoire, Equatorial stabilize the yen at about pre-earthquake levels, Guinea, Ethiopia, Gabon, Ghana, Guinea, Kenya, Madagascar, Mali, Mauritius, Mozambique, Namibia, Niger, Nigeria, Rwanda, Senegal, South Africa, Tanzania, Uganda, and Zambia. 18History 3Asia excluding China. suggests that levels of imports of countries hit by cri- 4Bulgaria, Croatia, Hungary, Latvia, Lithuania, Poland, Romania, and Turkey. ses tend to stay below precrisis trends for a long time (see Chapter 5Argentina, Brazil, Chile, Colombia, Mexico, Peru, and Venezuela. 4 of the October 2010 World Economic Outlook). 6Regional groupings follow WEO classifications.24 International Monetary Fund | April 2011

CHAPTER 1 GLOBAL PROSPECTS AND POLICIES following an abrupt and unwarranted apprecia- A pessimistic reading of developments in global tion. The euro has depreciated by roughly 10 per- imbalances and their role in further recovery is cent. All three currencies are now broadly in line confirmed by the latest developments and WEO with medium-term fundamentals. The U.S. dollar projections. Global current account imbalances are is about 5 percent below its 2007 level yet still projected to remain wide (Figure 1.17, top panel). remains somewhat high relative to its fundamen- Specifically, projections foresee no domestic demand tals (Figure 1.17, bottom panel). acceleration relative to precrisis trends in Asian• Among emerging market surplus currencies, the economies with excessive current account surpluses. renminbi and the currencies of other Asian sur- Savings-investment projections tell a similar story plus economies (for example, Malaysia, Singapore, (Table A16 in the Statistical Appendix). Consistent Thailand) have appreciated by 5 to 10 percent. with a soft landing, saving rates in developing Asia Nonetheless, Asian currencies are weak relative to are projected to rise by about 1¼ percentage points medium-term fundamentals (Figure 1.17, bottom of GDP through 2016, while investment rates move panel). The currency of China still appears sub- broadly sideways—similar to projections in the stantially weaker than warranted by medium-term October 2010 World Economic Outlook. As a share fundamentals; the Korean won, which depreci- of global GDP, savings in developing Asia would ated by some 25 percent during the crisis, is also rise noticeably, exceeding precrisis levels sometime weaker than warranted. around 2013. Moreover, as discussed in Box 1.2, if• A few emerging market economies are bearing a conditions in Asia are already more overheated than disproportionate share of global demand rebalanc- is captured in the WEO projections, global imbal- ing. This may reflect their more flexible exchange ances could again widen appreciably unless exchange rates and more open capital accounts than their rates are allowed to appreciate. peers in Asia. Latin American currencies have Emerging market surplus economies remain hesi- typically appreciated in real effective terms, as tant about allowing their exchange rates to appreci- have the currencies of other emerging market ate. Some point to the experience of Japan following economies (see Figure 1.18, middle and bottom the Plaza Agreement as cause for concern about such panels)—this has raised competitiveness concerns, a strategy. However, a reading of this experience and for example, in Brazil, Colombia, South Africa, that of others suggests that rebalancing away from and Turkey. foreign demand need not come at the expense of Accumulation of official foreign exchange strong growth.19 The conditions facing Japan were inreserves in the major surplus economies presents an many ways unique, and the bad post-Plaza outcomeimportant obstacle to global demand rebalancing. was due largely to a credit bubble that developedDuring 2008–10, surplus economies in Asia–– after exceptional policy stimulus was combinedmostly China––used inflows on current and private with financial sector deregulation. When the bubblecapital accounts to accumulate reserves (see Figure burst, exposing underlying vulnerabilities, political1.17, middle panel). Although these economies economy constraints meant that restructuring pro-understandably want to have an adequate buffer gressed too slowly (Box 1.4). The Japanese experi-against the volatility of capital flows, a key motiva- ence thus underlines the importance of prompttion for the acquisition of foreign exchange reserves corrective policy actions in emerging market as wellseems to be to prevent nominal exchange rate as advanced economies.appreciation and preserve competitiveness. In some In sum, global demand rebalancing remains aeconomies, this is delaying required internal adjust- major concern for the sustainability of the recoveryments, contributing to excessively rapid credit over the medium term. Activity in the United Statesgrowth and asset price booms; in others, steriliza- may firm up during 2011. Little real exchange ratetion presents a growing budgetary burden, without appreciation may be boosting activity in China,having much effect on the fundamental drivers ofcapital flows. 19See Chapter 4 of the April 2010 World Economic Outlook. International Monetary Fund | April 2011 25

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERYFigure 1.19. Unemployment1 while fundamental reforms to boost consumption are being put in place. But unless fiscal adjust-Unemployment remains above precrisis levels in many economies, including the ment soon starts in earnest in the United States,United States. Globally, unemployment is expected to average about 6 percent this the exchange rate of the renminbi becomes moreyear, with rates ranging from 4 percent in east Asia to 10 percent in the Middle East.Unemployment rates are projected to be lower in regions where growth was higher market-determined, currencies of other emerginglast year. Youth unemployment remains high, at 25 percent in the Middle East and surplus economies appreciate, and various Euro-between 15 and 20 percent elsewhere. Employment-to-population ratios are low inmany regions suggesting that many people are being forced into the informal sector. pean and emerging economies implement ambitious structural reforms, little progress will be made Unemployment 6 with respect to global demand rebalancing, and the (latest unemployment rate minus six-year average before the crisis) 4 recovery will stand on increasingly hollow legs over the medium term.20 2 0 -2 Unemployment Needs to Be Reduced -4 Unemployment poses grave economic and social -6 challenges, which are being amplified in emerging and developing economies by high food prices -8 AU CA FR DE IT JP KR GB US AR BR CN ID MX RU ZA TR EU (Figure 1.19). The young face particular difficulties. Projected Unemployment Rate, Ratio of Unemployment Rate, by Historically, for Organization for Economic Coop- by Region, 2011 Region (2011), to Annual Real GDP eration and Development countries the unemploy- 12 (percent) Rate, by Region (2010) 12 ME ment rate for young people ages 15 to 24 has been 10 NAF 10 DEEU CEECIS about two and a half times the rate for other groups. 8 SSA LAC 8 Though youth unemployment typically increases 6 sharply during recessions, the increase this time was 6 EAS greater than in the past: in a set of eight countries SEAP 4 SAS 4 for which long time-series of youth unemployment 2 2 are available, the increase averaged 6½ percentage points during the Great Recession, compared with 4 0 0 percentage points in previous recessions. ME NAF CEECIS DEEU SSA LAC SEAP SAS EAS 0 2 4 6 8 10 12 The three lines of defense against unemployment 35 Youth Unemployment in Major Employment-to-Population Ratio, 80 are supportive macroeconomic policies, financial Regions 2010 30 (percent) 2010 70 sector repair, and specific labor market measures. 2000 60 Monetary policy is expected to stay easy in advanced 25 50 economies. However, there is an urgent need to 20 40 accelerate bank restructuring and recapitalization 15 to relaunch credit to small and medium-size firms, 30 10 20 which account for the bulk of employment. Tem- 5 10 porary employment subsidies targeted at these 0 0 firms could help restart hiring. Such programs may CEECIS EAS SEAP SSA LAC SAS DEEU NAF ME DEEU CEECIS LAC SEAP SSA SAS EAS ME NAF subsidize the hiring of many workers who would have found jobs anyway or cause replacement of Sources: Haver Analytics; International Labor Organization; and IMF staff estimates. those currently employed with the targeted group of 1AR: Argentina; AU: Australia; BR: Brazil; CA: Canada; CEECIS: central and southeastern unemployed.21 However, to the extent that subsidies Europe (non-EU) and Commonwealth of Independent States; CN: China; DE: Germany; DEEU: developed economies and European Union; EAS: east Asia; EU: euro area; FR: flow to small and medium-size firms, they may at France; GB: United Kingdom; ID: Indonesia; IT: Italy; JP: Japan; KR: Korea; LAC: Latin America and the Caribbean; ME: Middle East; MX: Mexico; NAF: north Africa; RU: Russia; 20For a full-fledged scenario to illustrate the benefits of joint SAS: south Asia; SEAP: southeast Asia and the Pacific; SSA: sub-Saharan Africa; TR: Turkey; US: United States; ZA: South Africa. policy action along these lines, see Group of Twenty (2010). 21See Chapter 3 of the April 2010 World Economic Outlook.26 International Monetary Fund | April 2011

CHAPTER 1 GLOBAL PROSPECTS AND POLICIESleast help alleviate the effects of still-tight bank lend- emerging market economies. Addressing the variousing conditions. Where unemployment has increased macroeconomic and financial policy challenges isfor structural reasons or where it was high even essential for stronger output and employment growth.before the crisis, broader labor and product market Advanced economies urgently need to make morereforms are essential to create more jobs. progress in addressing medium-term problems. High The high and increasing burden of unemploy- on the priority list are financial repair and reformsment on young people poses risks to social cohe- and medium-term fiscal adjustment. Financial sectorsion.22 Youth unemployment tends to be high in measures hold the key to more rapid macroeconomiceconomies with labor markets that offer strong job policy normalization, which would help guardprotection to experienced workers, feature high against the buildup of new imbalances, includingminimum wages, and offer insufficient apprentice- in emerging market economies. In general, moreship programs and vocational training. In many certainty about policy prospects could help supportemerging and developing economies, strong job the recovery of investment and employment whileprotection in the formal sector pushes employ- anchoring financial markets.ment, especially of the young, into the informal Many emerging and developing economies appear tosector. The right policy response is to find a middle have enjoyed a large improvement in output-inflationground––through appropriate product and labor performance over the past decade, akin to what hasmarket regulation––between the protected/formal been termed the “Great Moderation” in advanced econ-and unprotected/informal segments of the labor omies. The challenge for emerging and some develop-market. Spain, for example, has initiated reforms in ing economies is to ensure that this “real” moderation isthis direction. Lowering the fixed costs of employ- not harmed by rising food and commodity prices andment supports hiring in times of high uncertainty. growing financial excesses. With changes in monetaryIn addition, strong apprenticeship programs are or fiscal stances affecting the economy only with appre-needed for those who cannot attend university. ciable lags, the time for policymakers to act is now, lest another boom-bust cycle develop. Appropriate action differs across economies, depending on their cycli-Policies Are Not Yet Sufficiently Proactive cal and external conditions. However, a tightening of Many old policy challenges remain unaddressed, macroeconomic policies is needed in many economies.while new ones come to the fore. Old challenges that In emerging economies with large external surpluses,continue to loom large include repairing and reform- exchange rate appreciation is necessary to maintaining financial sectors; specifying medium-term fiscal internal balance––reining in inflation pressure andadjustment plans and entitlement reform in advanced excessive credit growth––and assist in global demandeconomies; and implementing exchange rate and rebalancing. Prudential tools and capital controls canstructural policies that foster global demand rebalanc- play a useful complementary role but should not serveing in emerging market economies with large external as substitutes for macroeconomic tightening. Socialsurpluses. The main new challenges relate to disrup- policies need to offer the poor sufficient protectiontions to the supply of commodities and growing from high food prices.macroeconomic and financial risks in key emerging Greater progress in advancing global demand rebal-market economies. In the meantime, unemployment ancing is essential to put the recovery on a strongeris very high in many advanced and a number of footing over the medium term. This will require actions by many, notably fiscal adjustment in key 22Surveys conducted in the United States from 1972 to 2006 external deficit economies and greater exchange ratefound that individuals who have lived through a recession dur-ing the formative years between 18 and 25 tend to believe less flexibility and structural reforms that eliminate distor-in personal effort, perceive stronger inequalities, and have less tions that boost saving in key surplus economies.confidence in public institutions (see Giuliano and Spilimbergo, The broad contours of the macroeconomic policy2009). There is also evidence that the adverse effects on lifetimeearnings are most pronounced for those who are unemployed response sketched here were very well received at thewhen they are 18 to 25 years old (see Kahn, 2010). G20 meeting in Seoul in November 2010. However, International Monetary Fund | April 2011 27

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERY with the peak of the crisis behind policymakers, the description of how the FCIs are forecast, and assesses imperative for action and willingness to cooperate historical FCI-based output gap forecasts. are diminishing. It would be a mistake for advanced FCIs can be broadly considered as a weighted economies to delay fiscal adjustment until emerging average of various indicators of financial conditions. market surplus economies remove distortions that They are standardized to have a zero mean and a are holding back global demand rebalancing. While standard deviation of 1—positive values represent the removal of distortions that boost saving in key a tightening of financial conditions and negative emerging external surplus economies would help values represent an easing. One useful feature of the support growth and achieve fiscal consolidation in FCIs is that they can be decomposed into contribu- key advanced economies, insufficient progress on tions from each of the indicators that went into their this front should not serve as an excuse for fiscal construction. Figure 1.20 shows FCIs for the United inaction. Furthermore, many emerging market econ- States and the euro area, along with total contribu- omies cannot afford to wait until advanced econo- tions from three types of indicators: spreads (interest mies tighten their policies before proceeding to enact rates, interest spreads, yield curves), prices (exchange substantial tightening themselves. The task facing rates, prices), and quantities (money, credit, bank policymakers is to convince their national constitu- lending surveys). encies that these policies are in their best economic interests, regardless of what others are doing. Policymakers will need to ensure that adjustment Estimating FCIs and structural reform do not hollow out support for The FCIs are estimated using a dynamic factor globalization. On the one hand, it is reassuring that model (DFM).24 The DFM assumes that each stan- economies eschewed protectionism during the Great dardized indicator of financial conditions, yt, can be Recession. On the other hand, it is disconcerting that decomposed into a common component, χt, and an support for open markets seems to be waning, as evi- idiosyncratic component, εt.The common component denced, for example, by disappointing progress in the captures the bulk of the covariation between yt and the Doha Round. Open trade has been a strong engine other indicators in the data set, whereas the idiosyn- of growth. If the design of expenditure and taxation cratic component is assumed mainly to affect only yt: policies and structural reforms does not foster popular yt = χt + εt , where εt ∼ N(0, ψ), (A.1.1.1) support for globalization, there is a risk that activity in advanced and emerging as well as developing econo- where χt = λFt. The common component is thus mies will settle on a much lower growth path than simply a scaled common factor, Ft , which is esti- during the decade preceding the crisis. Policymakers mated using the entire set of financial indicators. will thus need to pay greater attention than ever to The FCI is defined to be this common factor. the impact of adjustment on income distribution. The dynamics of the FCI are captured by an autoregressive process: Appendix 1.1. Financial Conditions Indices Ft = Σp βi Ft–i + νt, where νt ∼ N(0, 1), i=1 The author of this appendix is Troy Matheson. (A.1.1.2) Financial Conditions Indices (FCIs) have recently where the βis are coefficients and p is the lag length been developed for the United States and the euro of the process. The lag length, p, is selected using the area for use in assessing current financial conditions Swartz-Bayesian information criteria (SBIC). and how they may evolve over the medium term.23 This appendix discusses the methodology and indicators used to develop the FCIs, provides a brief 24See Giannone, Reichlin, and Small (2008); Matheson (2010, 2011); and Liu, Romeu, and Matheson (forthcoming). The detailed assumptions underlying the model and its estimation 23Swiston (2008) developed an FCI for the United States using with the Kalman filter can be found in Giannone, Reichlin, and a different methodology from the one used here. Sala (2005).28 International Monetary Fund | April 2011

CHAPTER 1 GLOBAL PROSPECTS AND POLICIES A key advantage of this framework is that FCIscan be estimated when values for some indicatorsare missing due to publication lags, which allows allavailable information to be used in a timely fashion.Data Description For each country, selecting data from a broad setof financial indicators is a crucial step. Most seriesare measured at a monthly frequency, with theremainder measured at daily or quarterly frequen- Figure 1.20. Financial Conditions Indices1cies. Before estimation, all series are converted (Positive = tightening; standard deviations from average)to monthly frequency, transformed to be free oflong-term trends (nonstationarity), if necessary, United States 5and standardized.25 The sample period for the FCIs Spreads 4used here begins in 1994. Indicators that are not Prices Quantities 3available for the entire period, such as survey datafor the euro area, are backdated using the DFM. 2In practice, the FCIs are forecast to the end of the 1quarter for which the most recent financial indica- 0tors are available. -1 The indicators used in each country’s FCI and -2information about how the indicators are classified 2000 02 04 06 08 10 12: Q4and transformed are available online (www.imf.org/weoforum). The online tables also include estimated Euro Area 5factor loadings, χ, which reflect the weight of each Spreads 4indicator. Each loading can take a positive or negative Prices Quantities 3value, depending on whether a high or low valueof the indicator in question implies a tightening or 2an easing in financial conditions. The Senior Loan 1Officer Survey (SLOS) data (for which a positive 0number indicates a tightening of financial conditions) -1generally have high positive factor loadings. Some of -2the indicators in the “spreads” category also have high 2000 02 04 06 08 10 12: Q4factor loadings, such as the BAA/10-year governmentbond spread in the United States and the high-yield Sources: Haver Analytics; and IMF staff calculations. 1Historical data are monthly, and forecasts (dashed lines) are quarterly.corporate/10-year government bond spread in theeuro area. Negative loadings generally predominate inthe “prices” categories, reflecting a tendency for pricesto rise when financial conditions ease. 25The quarterly series are interpolated, whereas the daily seriesare converted to monthly averages. Quarterly log differences aretaken of the nonstationary indicators. The remaining indicatorsare not transformed. International Monetary Fund | April 2011 29

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERY Forecasting Financial Conditions sive forecast (AR); a forecast from the baseline VAR, without the FCI; and forecasts from the baseline To forecast the FCIs, we adopt the following base- VAR augmented with each of the underlying indica- line closed economy quarterly vector-autoregressive tors separately.29 The RMSEs for each model relative model (VAR): to those of the AR are displayed in the right panels Yt AY,Y,i AY,π,i AY,r,i Yt–i μY,t of the tables; a number less than 1 indicates that the πt = Σi=1 Aπ,Y,i Aπ,π,i Aπ,r,i k πt–i + μπ,t , forecast is more accurate than the AR forecast. rt Ar,Y,i Ar,π,i Ar,r,i rt–i μr,t For both the United States and the euro area, the (A.1.1.3) forecasting performance of the VAR augmented with the FCI is good relative to the other models. The where Yt is the output gap, πt is headline inflation, FCI forecast outperforms the AR and all other VAR and rt is a short-term real interest rate (As are coef- forecasts for the United States. For the euro area, the ficients, μs are residuals, and the lag length of the FCI forecast is at least as accurate as almost all other process is k).26 models, with the VAR augmented with an indicator For each country, the FCI is added to this baseline from the SLOS the only exception. VAR, and FCI forecasts are made conditional on the projected paths for the other variables. Specifically, given forecasts for the output gap, inflation, and real Appendix 1.2. Commodity Market interest rates,27 the augmented VAR is essentially Developments and Prospects used to “back out” the implied FCI forecast. The authors of this appendix are Thomas Helbling, Shaun Roache, and Joong Shik Kang. Nese Erbil, Forecasting Performance Marina Rousset, and David Reichsfeld provided research assistance. An out-of-sample forecast evaluation exercise is conducted for the period from the first quarter of 2004 to the present to gauge the reliability of Overview of Recent Developments and Prospects the FCI forecasts. The FCI is estimated once every Prices of all major commodities have risen quarter using all data that would have been avail- strongly since mid-2010, rather than broadly able at the beginning of the third month of each stabilizing as expected at the time of the October quarter.28 All variables are forecast using the VAR 2010 World Economic Outlook. The overall IMF (with no conditioning information). Using the latest commodity price index rose by 32 percent between available estimates of the output gap as the target for June 2010 and February 2011. The price index has the forecasts, root mean squared errors (RMSEs) are now recovered more than half the decline from the computed for forecasts two and four quarters ahead cyclical peak in July 2008 and remains high in real of the real GDP data that would have been available terms. Food price gains were particularly promi- at the time. nent in the second half of 2010, while oil supply For comparison purposes, RMSEs are also com- risks have taken center stage with the unrest in the puted for a variety of other forecasts: an autoregres- Middle East and North Africa (MENA) since late 26Inflation and the real interest rate are de-meaned prior to January 2011. estimation. The spread of unrest to oil exporters in the 27These are taken from a much larger, more sophisticated MENA region has raised oil supply risks and led to model—the Global Projection Model, GPM (Carabenciov and some small oil supply disruptions, as output losses in others, forthcoming). 28Due to a lack of available data, the data vintages that would Libya have largely been offset by higher production have existed in real time are not used. Instead, the most recent in Saudi Arabia and other producers in the Persian vintage of data is used to simulate the data available each time a forecast is made. Real-time output gaps and short-term real interest rates are simply truncated from the most recent GPM 29In each quarter, all VARs and ARs are reestimated, and all lag estimates. lengths are reselected using the SBIC.30 International Monetary Fund | April 2011

CHAPTER 1 GLOBAL PROSPECTS AND POLICIESGulf. In response to this shock, oil prices rose fromabout $95 a barrel in late January to $110 in earlyMarch, partly reflecting increases in desired invento-ries for precautionary reasons. Figure 1.21. Commodity Prices Beyond this so far mild oil supply shock, how-ever, much of the unexpected commodity price Commodity Price Indices Commodity Prices and (January 2003 = 100; based on Economic Cyclestrength since mid-2010 has reflected easing fears 500 prices in U.S. dollars) 15 (year-over-year percent 60of a double dip due to financial stress in the euro Energy change) 10 40area and cyclical momentum, given steady upward 400revisions to global economic growth last year Metals 5 20 300(Figure 1.21, top panels). Commodity-intensive 0 0emerging economies, including China, remain 200 -5 IMF -20important contributors to demand growth, but Food commodity Worldconsumption, particularly of energy, has also recov- 100 price index -10 industrial (right scale) -40 Agricultural raw productionered rapidly in advanced economies. In some cases, Beverages materials (left scale) 0 2003 -15 -60demand growth has been stronger than expected, 06 08 10 Dec. 1998 2002 06 Jan. 12 11given past relationships between economic growthand commodity consumption, which highlight the APSP Spot and Futures1 Copper Spot and Futuresuncertainty caused by structural changes in com- 140 (U.S. dollars a barrel) (U.S. dollars a metric ton) 12000 Mar. 29,modity markets due to fast, commodity-intensive 120 Mar. 29, 2011 2011 10000growth in emerging market economies. The supply 100response to stronger-than-anticipated demand has 8000 80as usual been limited, as reflected in low short- 6000term supply price elasticities. As a result, market 60 Sep. 30, Sep. 30,equilibrium was achieved with unexpectedly large 40 2010 2010 4000 Jun. 30, Jun. 30,draws on inventories for many commodities. Tight- 20 2010 2010 2000ening in physical commodity markets is evident in 0 0the flattening of futures curves and, in some cases 2003 06 09 Dec. 2003 06 09 Dec. 13 13including oil and copper, a shift into backward-ation (Figure 1.21, middle panels). Net Flows to Commodity Net Financial Inflows into Weather-related supply shocks were important in Exchange-Traded Funds (ETFs) Commodities 14 (three-month moving sum; (billions of U.S. dollars) 100food markets in the second half of 2010. Specifically, billions of U.S. dollars) Index swaps 12 Diversifiedadverse weather conditions during 2010 led to harvest Agriculture ETFs and medium-term 80 10 notesshortfalls in wheat (Russia, Ukraine), rice, rubber, cot- Industrial metals 8 Energy 60ton, and local vegetables (south and southeast Asia), 6 Totalcorn (United States), and sugar (India). One of the 40 4strongest La Niña weather events in 50 years contrib- 2 20uted to some of these conditions, particularly in Asia. 0 0Demand remained robust, partly reflecting a sharp -2rebound in biofuel production. The price responses -4 Jun. 08 09 Dec. 2000 02 04 06 08 10 -20to supply setbacks were exacerbated by trade restric- 2007 10tions (for example, grain export bans in Russia and Sources: Bloomberg Financial Markets; and IMF staff estimates.grain export quotas in Ukraine in 2010). All of these 1APSP (average petroleum spot price) denotes an equally weighted average of threedevelopments delayed restocking and kept inventories crude spot prices: West Texas Intermediate, Dated Brent, and Dubai Fateh.for some important crops very low. Monetary policy developments and improving finan-cial conditions also contributed to higher commodity International Monetary Fund | April 2011 31

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERY prices, in part by keeping inventory financing costs lower some easing in demand-supply balances and for a for longer than expected earlier in 2010. In addition, moderation of upward price pressures. renewed U.S. dollar depreciation has also played a role. Commodity price risks remain tilted to the upside, The financialization of commodity markets con- however, with the possibility of supply shortfalls tinued apace, with commodity assets under financial still being the main concern. Oil price risks are a management reaching a new high of about $376 particular concern, given the combination of some- billion at the end of 2010.30 Net flows into both what weaker but still strong global growth, reduced exchange-traded products and commodity index downside risks to global growth from other sources, swaps were substantial and similar to levels seen in and increased geopolitical oil supply hazards. So far, 2009, indicating strong interest among both retail the market response to the supply disruptions in and institutional investors (Figure 1.21, bottom Libya has been modest in historical comparison, given panels). The effects of these flows remain the subject the magnitude of lost supply. Offsetting production of debate but, in theory, the price impact of com- increases by other members of Organization of Petro- modity financial investment is ambiguous. On one leum Exporting Countries (OPEC) have provided an hand, well-informed, rational investors should add element of stability, but perceptions of oil supply risks liquidity to the commodity derivatives markets and could still become more volatile, especially in an envi- thereby lower price volatility. Their presence should ronment of robust growth. Food price risks remain also facilitate price discovery and keep prices more elevated because of low inventory buffers. closely aligned with underlying demand-supply fun- Beyond the next 12 months, the capacity for sup- damentals. On the other hand, ill-informed investors ply to keep pace with the level of demand consistent could follow their emotions or rigid investment rules with WEO growth projections has become more rather than fundamentals, which would add to price uncertain for a broad range of resources, includ- volatility. Mirroring the ambiguities on the theoreti- ing crude oil as highlighted in Chapter 3. Over the cal side, there is no solid empirical evidence to sup- medium term, real commodity prices will likely need port the claim that commodity financial investment to stay high, or even rise further, to ensure addi- has been a major factor in recent price cycles or in tional supplies of higher-cost resources. commodity price formation more generally. Energy Market Developments and Prospects Outlook Oil prices have surged to about $110 a bar- Macroeconomic prospects remain supportive for rel, as precautionary demand and risk premiums commodity prices. WEO growth projections suggest have increased in response to the oil supply shock that emerging market economies, including China, triggered by events in the MENA region. Before will continue leading the expansion. Demand growth the onset of the unrest in the region, oil prices had is expected to slow somewhat, however, partly because already moved decisively above the $70–$80 range economic growth in some major emerging market that had anchored price fluctuations through much economies is projected to moderate. In addition, com- of 2010. Short-term oil price volatility (as measured modity consumption may realign with activity levels by implied volatility on three- and six-month oil rather than growing faster than activity as in 2010. futures call options) has remained low, notwith- The supply response to higher demand is widely standing increased oil supply risks, close to the aver- expected to pick up, and futures prices reflect expec- age levels registered before the global financial crisis. tations that spare capacity will be tapped in some The run-up in oil prices preceding the onset of sectors at current high prices (oil) and that weather the oil supply shock reflected a number of factors. conditions will return to normal (food). Overall, the Annual growth in oil demand in 2010 was 3.4 commodity price projections are thus predicated on percent, the highest rate since 2004 and roughly twice the rate expected at the beginning of the year 30According to estimates by Barclays Capital. (Table 1.2; Figure 1.22, top-right panel). Part of32 International Monetary Fund | April 2011

CHAPTER 1 GLOBAL PROSPECTS AND POLICIESTable 1.2. Global Oil Demand and Production by Region(Millions of barrels a day) Year-over-Year Percent Change 2011 2010 2010 2004–06 2011 2010 2010 2009 2010 Proj. H1 H2 Avg. 2007 2008 2009 2010 Proj. H1 H2DemandAdvanced Economies 44.9 45.7 45.6 45.2 46.2 0.5 –0.4 –3.5 –4.0 1.8 –0.2 0.6 2.9 Of Which: United States 19.1 19.5 19.6 19.3 19.7 1.1 –0.1 –5.9 –3.7 2.4 0.3 1.6 3.2 Euro Area 10.5 10.5 10.3 10.3 10.6 0.1 –1.5 –0.6 –6.0 –0.3 –1.1 –2.8 2.2 Japan 4.4 4.4 4.3 4.4 4.4 –1.4 –3.1 –4.9 –8.8 1.3 –2.8 0.7 1.9 Newly Industrialized Asian Economies 4.6 4.9 4.9 4.8 4.9 1.5 4.5 –1.5 3.5 5.5 1.4 5.8 5.2Emerging and Developing Economies 40.1 42.2 43.8 41.6 42.8 4.4 4.3 3.1 1.9 5.2 3.6 5.4 5.0 Of Which: Commonwealth of Independent States 4.0 4.3 4.4 4.2 4.4 1.2 2.5 2.7 –5.4 7.1 2.5 6.3 7.8 Developing Asia 23.6 24.9 25.9 24.8 24.9 4.9 5.2 1.7 5.6 5.5 4.2 6.1 4.8 China 8.4 9.4 10.0 9.1 9.6 9.4 4.6 2.3 8.0 12.0 6.5 14.5 9.9 India 3.3 3.3 3.4 3.4 3.3 3.9 6.5 4.0 5.7 2.3 3.2 2.6 2.0 Middle East and North Africa 8.7 9.0 9.3 8.8 9.1 5.3 3.6 5.4 3.2 3.2 3.0 3.7 2.8 Western Hemisphere 5.6 5.9 6.1 5.8 6.0 4.4 5.7 5.4 0.1 5.0 3.3 4.8 5.1World 85.0 87.9 89.4 86.8 89.0 2.1 1.6 –0.6 –1.3 3.4 3.5 2.9 3.9ProductionOPEC (current composition)1,2 33.5 34.5 35.7 34.2 34.8 4.4 –1.0 2.9 –6.0 4.7 3.5 2.9 3.1 Of Which: Saudi Arabia 9.5 9.8 ... 9.6 9.9 2.4 –4.7 4.2 –9.1 3.1 ... 1.7 4.6 Nigeria 2.1 2.4 ... 2.3 2.5 2.3 –4.7 –8.2 –0.4 16.1 ... 16.3 16.0 Venezuela 2.4 2.4 ... 2.4 2.4 3.2 –7.8 –2.0 –7.8 3.1 ... 4.7 1.5 Iraq 2.5 2.4 ... 2.4 2.4 15.5 9.9 14.3 2.5 –2.2 ... –1.1 –3.3Non-OPEC2 51.7 52.8 53.6 52.6 53.1 0.8 0.8 –0.2 1.8 2.2 1.5 2.6 1.8 Of Which: North America 13.6 14.1 14.2 14.0 14.3 –1.2 –0.5 –3.8 2.2 3.7 0.3 3.6 3.7 North Sea 4.2 3.8 3.7 4.0 3.6 –6.8 –5.0 –5.0 –4.3 –8.8 –2.0 –7.4 –10.4 Russia 10.2 10.5 10.5 10.4 10.5 4.8 2.4 –0.7 2.0 2.4 0.6 3.0 1.7 Other Former Soviet Union3 3.1 3.1 3.2 3.1 3.1 9.0 11.5 3.2 9.2 1.1 2.7 2.2 0.0 Other Non-OPEC 20.6 21.4 22.0 21.1 21.6 1.7 1.1 3.2 1.8 3.6 3.2 4.0 3.2World 85.2 87.4 89.4 86.8 87.9 2.2 0.1 1.0 –1.4 3.2 1.6 2.7 2.3Net Demand4 –0.2 0.6 0.0 –0.1 1.2 –0.4 1.3 –0.3 –0.2 0.7 ... –0.1 1.3 Sources: International Energy Agency, Oil Market Report, March 2011; and IMF staff calculations. 1OPEC = Organization of Petroleum Exporting Countries. Includes Angola (subject to quotas since January 2007) and Ecuador, which rejoined OPEC in November 2007 after suspending its member-ship from December 1992 to October 2007. 2Totals refer to a total of crude oil, condensates, natural gas liquids, and oil from nonconventional sources. 3Other Former Soviet Union includes Azerbaijan, Belarus, Georgia, Kazakhstan, Kyrgyz Republic, Tajikistan, Turkmenistan, Ukraine, and Uzbekistan. 4Difference between demand and production. In the percent change columns, the figures are percent of world demand. the stronger-than-expected oil demand growth is where fuel demand was stronger than expected, and explained by faster actual global economic growth in Japan, where oil-generated power substituted for in 2010, on the order of 1 to 1½ percent compared maintenance-related losses in nuclear power for part with forecasts in late 2009 and early 2010. Another of the year (Figure 1.22, top-left panel). part of the oil demand surprise reflects oil-specific Oil supply responded to the unexpected increase in factors, including energy policy shifts in China oil demand, but not to the full extent possible. Global that reduced the supply of electricity to some sec- oil production is estimated to have increased by 3.2 tors and led to increased diesel demand. Upward percent in 2010. Higher-than-expected non-OPEC surprises in oil demand were also recorded in major production contributed about half of the surprise advanced economies, notably the United States, increase in supply (Figure 1.22, upper-middle-right International Monetary Fund | April 2011 33

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERY panel). Declines in the North Sea were more thanFigure 1.22. World Energy Market Developments offset by higher production elsewhere, notably in Contribution to Global Annual Cumulative Growth since 2002:Q12 Brazil, China, Russia, and the United States, reflecting10 Growth of Oil Demand 25 Other emerging 120 incentives for investment and field decline manage- (percent) and developing 8 U.S. China 20 economies ment embodied in rising oil prices and, in the case Other industrial economies (left scale) 90 6 Emerging and 15 China of Russia, changes to the tax regime to cover high 4 developing 10 (right production and development costs. OPEC crude oil 2 economies 5 scale) 60 production, which is subject to production quotas, 0 0 30 rose by 1.8 percent, contributing one-quarter to the-2 World GDP1 -5 Advanced economies Total increase in global supply (Figure 1.22, upper-middle- (left scale)-4 -10 0 left panel). OPEC production of natural gas liquids 08: 09: 10: 10: 0 30 60 90 120 150 Q4 Q1 Q1 Q4 (NGLs, including ethane, propane, butane, and natu- OPEC Production Changes from Non-OPEC Oil Production4 ral gasoline) rose by more than 10 percent, contribut- 2 Peak 3 (contributions to change in overall (million barrels a day) production, percent) 2 ing another quarter of global supply growth. 1 2009 2010 With supply growth lagging, market clearing 0 1 Oct. 1997 -1 price peak required an unexpectedly strong draw on inventories -2 July 0 from the second half of 2010, and inventory-to-use -3 2008 ratios are now approaching average levels over past price -4 peak Nov. 2000 -1 cycles (Figure 1.22, lower-middle-left panel). Simi- North Sea Mexico and Other FSU non-OPEC Production Russia Other United States Total -5 price peak larly, oil futures curves flattened rather than sloping 1 5 9 13 17 21 24 upward as in the earlier stages of the global recovery, indicating an end to cyclical weakness in oil market Oil Market Buffers 2008–115 United States: Natural Gas 7 Natural gas as percent of 26 conditions. More recently, futures curves have moved 7 total electric power sector Mar. 10 Jul. 10 24 into backwardation, indicating a further tightening in 6 OPEC spare capacity 6 generation (right scale) 22 5 Cost to electricity 5 generating plants of 20 physical markets that is anticipated to ease somewhat 4 Feb. 08 Jan. 11 Jan. 09 18 through 2011. 3 4 natural gas relative Jan. 08 to coal 16 Near-term oil market prospects depend importantly 2 5-year 3 (left scale) 14 1 average 12 on prospects for greater stability in some oil exporters Jul. 08 2 0 10 in the MENA region and the interaction between the -50 0 50 100 150 OECD inventories 1 8 strength of the global expansion, oil demand dynam- 1992 96 2000 04 08 12 ics, and the supply response. Current WEO projec- Prices of Energy Commodities 140 tions point to moderating global economic growth (U.S. dollars a barrel of oil equivalent) Oil 120 over the next 12 months, suggesting a slowing of oil Australian 100 demand growth momentum. This should be rein- coal 80 Asian liquefied U.S. gas forced by a partial unwinding of the overshoot in oil natural gas 60 demand that typically accompanies the early stages of 40 recovery in global activity (see Chapter 3). 20 On the supply side, modest capacity growth is 01992 94 96 98 2000 02 04 06 08 10 Feb. expected in non-OPEC countries in 2011, reflecting 11 in part the oil investment bottlenecks of 2006–08. Sources: IMF Primary Commodity Price System; International Energy Agency, Oil Market Report, March 2011; and IMF staff calculations. As a result, the call on OPEC will increase mark- 1Annual change, in percent. 2Data through 2010:Q4 for advanced economies and China; through 2010:Q3 for edly in 2011 under the WEO baseline projections.31 emerging economies. GDP growth on x-axis, and oil demand growth on y-axis. 3Organization of Petroleum Exporting Countries (OPEC) membership as of the first 31The “call on OPEC” is the difference between global demand month of each episode. Months from oil price peak on x-axis. 4North Sea: Norway and United Kingdom. Other FSU: other former Soviet Union. and supply from sources other than OPEC crude oil production, 5Organization for Economic Cooperation and Development (OECD) stocks, deviations including OPEC NGL production. In Table 1.2, the figure for from five-year average (million barrels) on x-axis, OPEC effective spare capacity (million OPEC production in 2011 reflects the call on OPEC and OPEC barrels a day) on y-axis. NGL production.34 International Monetary Fund | April 2011

CHAPTER 1 GLOBAL PROSPECTS AND POLICIESOPEC production decisions will thus play a key rate of global oil production. The tensions arerole in determining oil market outcomes. OPEC expected to remain moderate in the WEO baseline.members have already begun to tap their spare As discussed in greater detail in Chapter 3, theycapacity to offset losses from supply disruptions in could intensify however, and on balance risks toother MENA region producers. This commitment prices remain on the upside given downside risk tohas helped keep oil supply risks in check. However, supply, reflecting above- and below-ground con-ensuring oil market stability with continued robust straints on oil investment and, as highlighted byglobal growth will likely require increases in OPEC events in the MENA region, geopolitical risks.crude oil production above and beyond those neces- Price differences across fossil fuels remain large,sitated by supply disruptions in the MENA region. and the shift in market share away from crude oilThe acceleration in OPEC crude oil production in is likely to continue (Figure 1.22, bottom panel).December 2010 and January 2011—when oil prices Natural gas prices in the North American marketwere closing in on the $100 a barrel threshold—sug- have remained low compared with those of crudegests that OPEC members remain concerned about oil, reflecting the additional supply from shale gasaccelerated price increases. Nevertheless, the absence extraction. The market share for natural gas will thusof an elastic production response when prices moved continue to increase in the United States, as end-beyond the $70–$80 range has led to some uncer- user demand responds further to price incentivestainty in markets about OPEC producers’ implicit (Figure 1.22, lower-middle-right panel). Natural gasprice targets. could also play a more prominent role in the energy The magnitude of the actual oil supply shock has, mix elsewhere, given that large shale gas depositsin historical comparison, been moderate to date. have also been identified in other regions.32 Simi-However, MENA oil supply risks will probably only larly, coal is relatively cheaper than crude oil, andgradually unwind through 2011. The oil supply risks coal consumption growth has exceeded that of otherand continued robust global activity—notwithstand- fossil fuels over the past decade, highlighting theing some slowing—means that upside risks to oil importance of coal in meeting rapidly growing worldprices will remain high. Oil derivative markets have demand for primary energy.indeed started to price in higher risks of price spikesover the next few years. Against this backdrop, oilmarket risks have become an important concern Metal Market Developments and Prospectsfor global economic stability, as discussed previ- Metal prices rallied strongly in the second halfously in the chapter. In contrast, the oil market risks of 2010 and early 2011, with the IMF base metalfrom the replacement of nuclear by thermal power price index increasing by 40 percent (Figure 1.23,in Japan because of the damage to nuclear plants top-left panel).33 As for commodities more gener-after the Tohoku earthquake should be minor. The ally, the sharp price increases were driven largely byreplacement will eventually lead to higher fossil the stronger-than-expected recovery both in emerg-fuel imports in Japan, but the impact on global oil ing market and in advanced economies, althoughdemand should remain limited, on the order of 0.1 supply disruptions also played a role. Reflecting theto 0.3 percent. Past experience and incentives from influence of common macroeconomic factors andcurrent energy prices suggest that more than half of increases in risk appetite across financial markets, thethe increased fossil fuel needs will be met through comovement between metal prices and global equityincreased imports of liquefied natural gas and, to a prices remained strong throughout 2010.lesser extent, coal. Global consumption of all base metals except tin In the medium term, even assuming that supply is estimated to have reached a new high in 2010disruptions in the MENA region are short-lived,oil prices are expected to remain high, reflecting 32Box 3.2 analyzes prospects for moving the U.S. shale gasthe tension between continued robust oil demand “revolution” to the global stage.growth and the downward shift in the trend growth 33 Copper and tin prices reached record highs. International Monetary Fund | April 2011 35

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERY (Figure 1.23, top-right panel).34 Supply responded Figure 1.23. Developments in Base Metal Markets to rising prices but only sluggishly, reflecting in part the impact of stricter environmental standards (for example, power-related aluminum production cuts Selected Metal Prices Base Metals: Global Demand in China) and labor disputes (for example, strikes (January 2006 = 100) Growth in Chile’s copper mines). As a result, inventory buf- 400 (year-over-year percent change) 40 Nickel Advanced China fers have been declining, normalizing to historical economies Other emerging 30 Futures averages. The stock-to-use ratio for copper is already 300 curves1 excluding NIEs 2 markets Lead below its historical average (Figure 1.23, middle-left Total 20 demand panel). The impact on overall inventory movements 200 growth 10 of newly introduced exchange-traded funds (ETFs) 0 backed by physical holdings of base metals has so far 100 Supply -10 been limited, reflecting features of these investment Copper Aluminum growth vehicles that are less attractive than futures-backed 0 -20 2006 08 10 12 14 Dec. 2003:Q1 09: 09: 10: 10: 10: alternatives under current market conditions.35 As of 15 –08:Q2 Q1 Q3 Q1 Q3 Q4 end-February, the share of London metal exchange stocks accounted for by these products varied Base Metals: Stock-to-Use Ratios Base Metals: China’s Share of 4 (standard deviations from average) Global Demand 50 between 0.1 to 2.3 percent. (percent) Turning to the outlook, the analysis in Box Aluminum Other base metals 3 Copper 40 1.5 of the October 2010 World Economic Outlook Other base metals3 2 Copper suggests that base metal markets are in a phase of 30 increased scarcity, as reflected in the rise of the 20 trend component in prices over the past decade or 0 so. Increased scarcity in base metals is due in part 10 Aluminum to increasing metal demand from emerging market economies, particularly China. During 2003–07, -2 0 1995 2000 05 Dec. 2000 06 07 08 09 10 10 China contributed two-thirds of the increase in –05 world consumption of aluminum and copper and Aggregate Metal Consumption China Real GDP Components and almost all the increase in world consumption of and GDP per Capita Metal Demand Growth 6 20 (1960–2009)4 16 40 lead, tin, and zinc (Table 1.3). Since 2008, China’s (year-over-year percent change) Korea contribution has exceeded even net world con-Consumption per capita (kilograms) 14 Metal 15 Japan consumption 30 sumption growth for all metals, with consumption (right scale) 12 of copper, lead, and nickel increasing by more 10 GDP 20 than 50 percent. Reflecting this strong growth, China 10 (left scale) China’s share in global base metal consumption has Euro United 5 area States 10 doubled to about 40 percent during the past 10 8 Fixed investment years (Figure 1.23, middle-right panel). Brazil (right scale) 0 6 0 10 20 030 40 50 2004 07 10 13 15 Real GDP per capita (thousands of PPP-adjusted U.S. dollars)5 34Base metal demand grew by more than 8 percent (year over year) during the second half of 2010, whereas global economic Sources: Bloomberg Financial Markets; London Metal Exchange; Thomson Datastream; growth was less than 5 percent (year over year) during the same World Bureau of Metal Statistics; and IMF staff estimates. 1Prices as of March 30, 2011. period. 2NIEs = newly industrialized Asian economies, which include Hong Kong SAR, Korea, 35Physically backed ETFs for copper, nickel, and tin were intro- Singapore, and Taiwan Province of China. duced in December 2010. Because these metals are trading in 3Weighted average of lead, nickel, tin, and zinc. 4Aggregate of aluminum, copper, lead, nickel, tin, and zinc. backwardation, a capital loss is expected from holding inventories 5PPP = purchasing power parity. in addition to the high physical carrying costs of inventories. In 6GDP and components in real terms, metal consumption in volume terms. contrast, the time spread works in favor of futures-backed alternatives, which can benefit from a positive roll yield.36 International Monetary Fund | April 2011

CHAPTER 1 GLOBAL PROSPECTS AND POLICIES Table 1.3. Consumption of Base Metals (Annual percent change unless noted otherwise) Growth in Consumption of China’s Industrial Aluminum Copper Lead Nickel Tin Zinc World GDP Production 1995–2002 World 3.2 3.4 3.1 2.2 1.5 3.7 3.4 10.9 Of Which: China (percent) 46.1 57.5 54.5 29.4 14.9 39.6 6.8 ... Other Emerging Markets1 (percent) 13.5 19.3 29.2 –8.9 14.5 11.2 ... ... 2003–07 World 8.0 3.8 4.7 3.0 6.0 3.8 4.7 16.6 Of Which: China (percent) 67.6 67.4 94.2 130.3 95.7 99.3 9.4 ... Other Emerging Markets1 (percent) 7.7 19.7 –0.7 –5.6 0.6 11.2 ... ... 2008–10 World 1.9 2.1 3.6 3.6 1.7 2.9 2.4 13.1 Of Which: China (percent) 159.5 226.3 175.5 153.0 104.3 166.7 12.3 ... Other Emerging Markets1 (percent) 5.2 –12.8 –9.3 –7.7 41.0 –0.3 ... ... Sources: World Bureau of Metal Statistics, World Metal Statistics Yearbook (various issues). 1Brazil, India, Mexico, and Russia. China’s metal consumption is currently higher structure construction and public housing projectsthan that of other countries at a similar stage of in the pipeline.36development, likely reflecting the exponentialgrowth in its manufacturing sector over the pasttwo decades (Figure 1.23, bottom-left panel). Food Market Developments and ProspectsHowever, China’s metal consumption growth is The IMF Food Price Index reached a new high dur-expected to moderate during 2011 and subsequent ing early 2011 after rising by about 41 percent sinceyears, given recent efforts to restrain bank lending mid-2010. Price increases have been broad-based andand infrastructure investment and the potential led by an 82 percent surge in grain prices, but somefor a gradual rebalancing of the economy away major grains, including rice, are still significantly belowfrom metal-intensive sources of growth (Figure their 2008 highs (Figure 1.24, top-left panel). Other1.23, bottom-right panel). The moderation in base food groups with higher income elasticity are pushingmetal consumption growth in China is expected past previous highs, however, including oilseeds, meat,to be partly offset by increased demand from sugar, and seafood (Figure 1.24, top-right panel). Noadvanced economies, where base metal consump- single factor explains the resurgence in food prices,tion still is some 15 percent below precrisis levels but the catalyst was a series of weather-related supplydespite ongoing recovery. The global demand shocks, including drought and wildfires in Kazakhstan,impact of temporarily higher metal demand due Russia, and Ukraine (wheat); a hot and wet summerto the reconstruction in Japan after the Tohoku in the United States (corn); and the more widespreadearthquake, however, is likely to be minor. effects of a particularly strong La Niña weather pattern Production and capacity growth, though respond- around the Pacific rim (rice, sugar, local vegetables).ing to high prices, is not expected to rise in lock- Together these shocks contributed to a 2.7 percentstep with demand, especially for copper, due to downward revision to global grain production forslow development of mining capacity and rising 2010–11 (Figure 1.24, upper-middle-left panel).37energy costs. Risks to the price outlook remainto the upside, as inventory buffers for most met- 36Described in China’s new five-year plan, which went intoals have been declining. Demand growth in China effect in January 2011. 37Refers to the projections by U.S. Department of Agricultureis expected to moderate, but there is potential for for the international marketing year 2010/11 for corn (maize),upside surprises given continued large-scale infra- rice, and wheat. International Monetary Fund | April 2011 37

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERYFigure 1.24. Developments in Markets for Major Food While supply has disappointed, demand for majorCrops food crops has remained robust, largely reflecting growth in emerging market economies. During the 450 Prices of Major Grains1 Price of Other Major Products1 400 most recent global recession, demand growth was (January 2006 = 100) (January 2006 = 100) 400 350 Corn Soybeans unusually strong and has now picked up to about 350 Rice Sugar 300 U.S. lean hogs 2.5 percent (Figure 1.24, upper-middle-right panel). 300 Wheat 250 250 200 Emerging market economies, including China, account 200 150 for 70 to 80 percent of demand growth during the 150 100 past three years. One notable recent development has 100 50 been the increasing presence of China as an importer in 50 0 global grain markets, especially corn, after many years 2006 08 10 Dec. 2006 08 10 Dec. 12 12 of self-sufficiency. Consumption of oilseeds, including Change in Global Supply-Demand Contribution to Global Demand soybeans, has been particularly strong, reflecting their 2 Projections since Mid-2010, 6 Growth for Major Crops, 6 2010–112 1996–20113 higher income elasticity, and China remains the world’s 1 (percent) 4 (percentage points) 4 largest oilseed importer by a large margin. 0 Demand for biofuel feedstock has also rebounded 2 2 -1 more rapidly than expected as the U.S. corn ethanol 0 0 -2 Advanced economies sector recovered from the widespread bankruptcies China -3 Demand -2 Other emerging and -2 of 2008–09. Ethanol operating margins remain Supply -4 -4 developing economies -4 thin, but the sector has retained considerable policy Wheat Corn Rice Oilseeds 1996 2000 04 08 11 support, which serves to buttress ethanol prices U.S. Ethanol Price Composition Major Grains: Area and Yield, (Figure 1.24, lower-middle-left panel). Higher prices and Operating Margins 1966–2010 4 (annualized 6 (U.S. dollars a gallon) 8 growth rate, percent) 180 of alternative feedstock, particularly sugar, have also Net cost of corn Area harvested (left scale) supported demand for corn-based ethanol. About 40 Other operating costs 6 Yield (left scale) 150 4 Return over operating Real grain price percent of the U.S. corn harvest—equivalent to 14 costs 4 index (right scale) 120 percent of total global corn consumption—was used 2 90 as ethanol feedstock in 2010, a 5 percentage point 2 increase over the previous year. 0 60 All these factors contributed to tighter physical 0 2005 06 07 08 09 Jan. -2 1966 76 86 96 06 30 markets that delayed the rebuilding of inventories 11 –70 –80 –90 –2000 –10 depleted during the nine years preceding the first Corn: Risk-Neutral Nine-Month Global Grain Inventories to global food price surge in 2008. For some food Price Density Function, 2008–11 Consumption, 1965–20115 18 (U.S. dollars a bushel) (percent) Global inventories 40 crops, especially corn, stocks remain very low, which 15 68 percent confidence to consumption 35 has exacerbated price volatility. 86 percent confidence 95 percent confidence The outlook for food prices over the near term and 12 30 Futures price beyond will depend largely on supply developments. 9 25 Average, History suggests that more normal weather condi- 6 1965–2010 20 tions over the next 12 months should allow harvests to 3 15 recover most of the losses incurred during 2010.38 For 0 10 example, during years in which global wheat output 2008 09 10 11: 1965 75 85 95 2005 11 Q1 declined by more than 5 percent, the subsequent year recorded an increase of 7 percent, significantly above Sources: Bloomberg Financial Markets; Chicago Mercantile Exchange; Iowa State trend growth. Over the medium term, supply should University Center for Agriculture and Rural Development; UN Food and Agriculture Organization; U.S. Department of Agriculture (USDA); and IMF staff calculations. continue to rise in response to higher prices. Yield 1Futures prices for March 2011 through December 2012. 2 USDA projection for the international year 2010/11. 38The best-fitting univariate time-series models of annual global 3 Includes grains and oilseeds. Demand for 2011 is projected by the USDA. 4 Area-weighted yield for nine grains and prices. production also indicate that supply shocks are typically reversed 5 End-year inventories as a percent of consumption, with USDA projections for 2011. quickly.38 International Monetary Fund | April 2011

CHAPTER 1 GLOBAL PROSPECTS AND POLICIESgrowth has slowed somewhat in recent years, possiblydue to reduced state funding of agricultural research Figure 1.25. Changes in International and Domesticand development in advanced economies.39 Offsetting Food Prices and Headline Inflationslower yield growth, acreage under cultivation has begun (Monthly; year-over-year percent changes)to increase, after two decades of stagnation, but the paceof expansion may remain gradual, in part reflectingthe relative scarcity of productive well-irrigated land in International (left scale)1 Headline (right scale)regions with a well-established distribution infrastruc- Domestic (right scale) 2ture (Figure 1.24, lower-middle-right panel). Improving supply should ease tightness somewhat 50 Emerging Western 24 60 Middle East 30 Hemisphereand allow prices to retreat modestly from their recent 40 20 45 25highs through 2011, but risks to the price outlook 30 20 16 30 15remain decisively to the upside. This view is reflected 20 10by market pricing, with futures curves relatively flat or 10 12 15 5backwardated, indicating that tightness should ease, 0 8 0 0whereas options suggest that risks have become more -10 -5skewed to the upside (Figure 1.24, bottom-left panel, 4 -15 -20 -10for corn). The most immediate risk is that the final -30 0 -30 -15 2000 02 04 06 08 Jan. 2000 02 04 06 08 Jan.phases of the current La Niña weather pattern will con- 11 11tinue to threaten yields in the Southern Hemisphere.Other risks include persistently higher energy prices 50 Emerging Asia 25 50 Africa 25or the imposition of international trade restrictions in 40 20 40 20response to supply shocks. Most important, global food 30 15 30 15inventories remain low, particularly for grains (Figure 20 10 20 101.24, bottom-right panel). The process of rebuilding 10 5 10 5stocks will take time, and until these buffers return 0 0 0 0to more normal levels, food prices will remain highly -10 -5 -10 -5sensitive to shocks that tighten physical markets. -20 -10 -20 -10 -30 -15 -30 -15 2000 02 04 06 08 Jan. 2000 02 04 06 08 Jan. 11 11Recent Commodity Market Developments:Implications for the Global Economy 50 Emerging Europe 35 50 Advanced Economies 10 The challenges posed by high and rising commodity 40 40 8 30prices are most immediate for emerging and develop- 30 30 6 25ing economies for two main reasons. First, the share 20 20 4of food in the typical consumption basket is larger in 20 10 10 2these economies than in advanced economies. As a 15 0 0 0result, the pass-through of food prices in international 10 -10 -10 -2markets to headline inflation tends to be higher in 5 -20 -20 -4these economies. Second, there is greater potential that -30 0 -30 -6changes in commodity prices will affect their terms of 2000 02 04 06 08 Jan. 2000 02 04 06 08 Jan. 11 11trade and trade balances, given relatively larger shares ofcommodities in both imports and exports. Sources: Haver Analytics; IMF Primary Commodity Price System; and IMF staff calculations. 1 IMF commodity food and beverage price index in U.S. dollars. 2 Food and beverage inflation. 39Discussed in Appendix 1.1 of the April 2010 World EconomicOutlook. International Monetary Fund | April 2011 39

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERY The upturn in headline inflation across many the expected price increases under the IMF’s updated emerging and developing economies has coincided baseline projections for commodity prices are substan- with a pickup in commodity prices since mid-2010 tial. The latest baseline anticipates increases in prices (Figure 1.25). In particular, higher food prices have for crude oil, food, and metals of about 31, 26, and contributed significantly to higher inflation. This 24 percent, respectively, in 2011, compared with the reflects the pass-through of world food prices, but October 2010 WEO baseline. Overall, the terms-of- also—in some significant cases, including China and trade gains from higher commodity prices are expected India—higher prices in local food markets, such as for to improve the trade balances of emerging and develop- fresh fruit and vegetables. Headline and fuel inflation ing economies by about 1¼ percent of GDP in 2011. have risen most in the Middle East, a region that is a However, variation across regions and economies is large net food importer, followed by emerging Asia, wide, as shown in Figure 1.26. Large terms-of-trade a region hit hard by bad weather in the second half gains from high oil export prices should more than off- of 2010 and output gaps that are either closing or set losses from high food import prices in the Middle already positive. In contrast, food prices and headline East; economies in emerging Asia and emerging Europe inflation are little changed in sub-Saharan Africa, are generally expected to experience declines in their where many economies are less integrated into global trade balances, reflecting their high dependence on food markets and have enjoyed relatively bountiful commodity imports. Within Africa, economies without local harvests over the past 12 months. The prices of any major commodity resources to export, especially oil some important staple crops, including corn (maize), and metals, would suffer most from high food prices. have thus remained relatively stable in much of the However, many net food importers benefit from the region, indicating that international food prices are natural hedge provided by their exports of metals, oil, only one factor in determining local food inflation. and other commodities. Most advanced economies are Further pass-through of recent commodity price expected to experience a modest deterioration in their increases to headline inflation seems likely across the terms of trade. global economy. Food prices remain the most impor- To assess the effects of further significant increases tant source of risk due to tight market conditions, in commodity prices, the same exercise was conducted which should ease only gradually, and their higher using price levels consistent with a plausible shock pass-through to domestic prices in emerging and derived from prevailing market expectations embed- developing economies. Some of the factors behind ded in commodity futures options. These derivative rising commodity prices are temporary, and first-round prices can provide an indication of the probability effects on headline inflation should generally be accom- distribution of prices over various time horizons.41 modated, but country-specific circumstances may In a scenario that compares the effects of higher food require a monetary policy response. The cost-push from prices relative to the current baseline, food prices are large commodity price increases is more likely to result assumed to be on average about 58 percent higher in second-round effects, including rising long-term in 2011 than the previous year. A scenario involv- inflation expectations, in economies where the weight ing broad increases in commodity prices was also of food and energy in the consumer price index is considered in which, in addition to higher food relatively large and monetary policy credibility not yet prices, all energy prices are assumed to be 53 percent solidly established—primarily in some emerging and higher than the previous year, and base metal prices developing economies (see Chapter 1).40 are assumed to increase by 40 percent. A summary of Recent commodity price developments have also these assumptions and the comparison with the cur- had a broad impact on the terms of trade and trade rent baseline are provided in Table 1.4. balances. The estimated direct (first-round) effects of The impact of higher food prices varies by region (Table 1.5). The overall effect on Africa is marginal, 40As noted in Chapter 3 of the October 2008 World Economic Outlook, emerging and developing economies are more likely 41Specifically, the upper standard deviation bound of the risk- than advanced economies to lack monetary policy credibility and neutral density function for the commodity price was selected as solidly anchored inflation expectations. the upside scenario.40 International Monetary Fund | April 2011

CHAPTER 1 GLOBAL PROSPECTS AND POLICIESFigure 1.26. First-Round Impact of Commodity Price Changes on the Trade Balances of Selected Emerging andDeveloping Economies 1(2011 April WEO forecast over 2010 October WEO forecast; 2011 trade balance in percent of 2009 GDP) Total Fuel Food OtherWestern Hemisphere Middle EastAntigua and Barbuda Mauritania Improvement Dominica St. Lucia The Bahamas Rep. of YemenSt. Vincent & Grens. Jamaica Islamic Rep. of IranDominican Republic Haiti Bahrain El Salvador Grenada Deterioration Qatar Colombia Improvement Saudi Arabia PeruTrinidad and Tobago Oman Argentina Bolivia Kuwait Belize Chile United Arab Emirates Ecuador Venezuela Libya Paraguay -10 -5 0 5 10 15 -5 0 5 10 15 20Asia Africa Kiribati Seychelles Tonga Lesotho Samoa Zimbabwe São Tomé & Príncipe Bangladesh Mauritius Nepal Morocco Vanuatu The GambiaI.R. of Afghanistan Djibouti Madagascar Solomon Islands Cape Verde Deterioration India Philippines Algeria Improvement Deterioration Burkina Faso Indonesia Improvement Zambia Côte dIvoire Vietnam Nigeria Malaysia Chad Mongolia AngolaPapua New Guinea Gabon Rep. of Congo Brunei Equatorial Guinea -10 -5 0 5 10 15 -10 -5 0 5 10 15 20Emerging Europe Deterioration Commonwealth of Independent States Macedonia, FYR Tajikistan GeorgiaBosnia & Herzegovina Moldova Albania Armenia Serbia Kyrgyz Republic Deterioration Turkey Improvement Croatia Russia Turkmenistan Poland Kazakhstan Romania Uzbekistan Hungary Azerbaijan -4 -3 -2 -1 0 1 -10 -5 0 5 10 15 Source: IMF staff calculations.1 Country export and import weights by commodities were derived from trade data for 2005–08. Economies are ranked by the overall change in the trade balance,with the largest 10 improvements and deteriorations shown in each figure, subject to data availability. International Monetary Fund | April 2011 41

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERY Table 1.4. Annual Price Changes for Key Commodities (Percent) Food Oil Metals Energy 2011 2012 2011 2012 2011 2012 2011 2012 Baseline 24.1 –4.7 35.6 0.8 26.5 –0.8 31.9 0.1 Food Price Shock 57.5 7.3 ... ... ... ... ... ... Overall Price Shock 57.5 7.3 53.4 18.2 39.8 12.1 53.4 18.2 Source: IMF staff calculations. but this masks large terms-of-trade losses for net Higher prices of food, fuel, and other commodities food importers, about 0.5 percent of GDP in 2011, also have important distributional effects. The urban relative to the baseline. The Middle East would poor, especially in emerging and developing economies, also experience large trade balance deterioration, by are more likely to suffer from high prices than other more than 0.4 percent of GDP in 2011. In contrast, income groups. For the rural poor, much will depend the dominance of food exporters in Latin America on land ownership, because farmers benefit from higher would lead to a significant improvement of about prices. Recent commodity price developments are likely 0.4 percent in the trade position. to be another setback to the poverty reduction achieved The effects of broadly higher commodity prices in the early to mid-2000s. Hence, another policy improve the external position of emerging econo- priority will be to mitigate the effects of higher prices mies, although regional variations are important. In of food and other commodities on the poor through particular, large improvements for the Middle East, targeted and cost-effective social safety nets.42 the former Soviet Union, Latin America, and Africa 42 See Chapter 3 of the October 2008 World Economic Outlook are partially offset by deterioration in emerging Asia and Coady and others (2010) on social safety net policies and and emerging Europe (Table 1.5). high commodity prices. Table 1.5. Trade Balance Impact of Higher Prices1 (Changes from baseline in percent of 2009 GDP) Higher Food Prices Higher Overall Prices 2011 2012 2011 2012 Advanced Economies 0.0 0.0 –0.4 –0.3 United States 0.0 0.0 –0.3 –0.3 Japan –0.1 –0.1 –0.8 –0.6 Euro Area –0.1 0.0 –0.7 –0.5 Emerging and Developing Economies 0.1 0.0 0.8 0.7 Africa –0.1 –0.1 2.5 2.0 Of Which: Net Food Importers –0.5 –0.3 3.8 3.3 Asia and Pacific 0.1 0.0 –0.5 –0.5 Of Which: Net Food Importers –0.1 –0.1 –0.6 –0.6 Commonwealth of Independent States –0.2 –0.1 2.7 2.4 Of Which: Net Food Importers –0.3 –0.1 3.1 2.6 Europe –0.1 0.0 –0.8 –0.5 Of Which: Net Food Importers –0.1 0.0 –0.7 –0.5 Middle East –0.4 –0.2 5.6 5.2 Of Which: Net Food Importers –0.4 –0.2 5.6 5.2 Western Hemisphere 0.4 0.2 1.0 0.7 Of Which: Net Food Importers –0.2 –0.1 0.9 0.9 Source: IMF staff calculations. 1Country export and import weights by commodities were derived from trade data for 2005–08.42 International Monetary Fund | April 2011

CHAPTER 1 GLOBAL PROSPECTS AND POLICIESBox 1.1. House Price Busts in Advanced Economies: Repercussions for Global Financial Markets Financial booms and busts in the advanced econo- Figure 1.1.1. Financial Disruptionsmies can have profound effects on global financialmarkets and global economic activity. Most recently, Other downturns Busts/crunches1a bust that started in a small segment of the U.S. Advanced Economies Emerging Economieshousing market interacted with financial imbalancesand vulnerabilities elsewhere, turning into the deepest Duration 2global recession since the Great Depression. But house 20 20price busts are nothing new. This raises the questions 16 16of how and why this time was different from previouscycles and what we can learn from this episode. 12 12 This box addresses these questions by building 8 8on recent research by Claessens, Kose, and Terrones(2011 and forthcoming). The main findings are that 4 4recent house price busts in advanced economies 0 0had more severe implications for global financial House Equity Credit House Equity Credit price price price pricemarkets because of (1) how widespread house pricebusts were this time around compared with earlier Amplitude2episodes and (2) the unusual synchronization and 0 0buoyancy of advanced and emerging market finan- -10 -10cial conditions in the run-up to the crisis. Global -20 -20factors that drive financial cycles seem to have -30 -30become stronger while country-specific factors have -40 -40receded, including in house price cycles. -50 -50How Did This Cycle Differ from Previous Cycles? -60 -60 -70 -70 House price busts in advanced economies House Equity Credit House Equity Credit price price price pricegenerally last 18 quarters and are associated witha 30 percent house price drop (Figure 1.1.1).1 In Source: IMF staff estimates.emerging markets, busts last for 15 quarters and 1Busts refer to the bottom quartile of house and equity priceare associated with a 40 percent house price drop. drops, respectively. Crunches refer to the bottom quartile of credit contractions.A key difference from previous cycles is that the 2Duration is the number of quarters between peak and trough.recent house price busts in the advanced economies Amplitude is the decline during the downturn. Duration corresponds to sample means, whereas amplitude corresponds towere shorter and shallower, yet more violent—the sample medians. Disruptions refers to the bottom quartile of theaverage price decline per quarter was steeper than downturn of each financial variable.in the past.2 Although some busts are ongoing, the duration of completed house price busts was only The main author of this box is Marco E. Terrones. 40 percent of the historical average, and the drop in 1House price busts are defined as more intense forms of house prices was only 60 percent of the norm.3house price contractions. To be considered a bust, real houseprices need to fall (from peak to trough) by more than 15percent. House price busts are typically associated with sharp Spain, Sweden, Switzerland, and United Kingdom. Housecontractions in economic activity. Moreover, they are longer price series are mostly from the Organization for Economiclasting and (by design) more severe than other downturns. Cooperation and Development and correspond to various 2Twenty-eight house price bust episodes were observed measures of indices of house or land prices, depending on thein the advanced economies during 1970:Q1–2007:Q4. The source country.advanced economies that have experienced at least one such 3Among ongoing house price busts, depth and durationbust include Austria, Canada, Denmark, Finland, France, are similarly less than what was typically observed in previousIreland, Italy, Japan, Netherlands, New Zealand, Norway, busts at comparable stages. International Monetary Fund | April 2011 43

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERY Box 1.1 (continued) 1.1.2 plots median growth rates for house prices, Figure 1.1.2. Effect of Advanced Economy equity prices, and real credit for advanced econo- House Price Busts mies that experienced a house price bust and, in (Percent change from one year earlier; t = 0 denotes peak; quarters on the x-axis) the panels on the right, for all emerging market economies at about the time of these busts. Over- Median changes in advanced economies during laid on this figure are data on current house price house price busts in these economies busts (left panels) and financial effects in emerging Median of current house price busts1 Declines in emerging market economies during markets (right panels). Note that during house price house price busts in advanced economies busts in advanced economies, house prices decline Declines in emerging market economies during for an extended period, typically about four years. recent busts in advanced economies 50 percent interval of changes during house price In contrast, house price growth rates in emerging busts in advanced economies market economies slow down somewhat during the first year of the event and then accelerate slightly. Effects on Advanced Effects on Emerging Economies Market Economies Figure 1.1.2 also shows that recent house price House Prices busts were accompanied by a sharp drop in equity 25 10 prices and a slowdown in credit. Credit and hous- 20 15 5 ing markets in many advanced economies remain 10 0 weak: households are highly leveraged and banks 5 are restructuring their balance sheets. Unlike in 0 -5 the past, however, the drop and recovery in equity -5 -10 prices have been rapid and steep. Also in contrast -10 -15 -15 with past experience, the effects of the recent price -8 -4 0 4 8 12 16 -8 -4 0 4 8 12 16 busts in emerging markets have been more severe: Equity Prices • House and equity prices in emerging market 50 40 40 30 economies have been more responsive to financial 30 20 developments in advanced economies; however, 20 10 they have recovered rapidly. In some economies, 10 0 house and equity prices are already reaching very 0 -10 -10 high levels, which in some cases exceed precrisis -20 -20 -30 -30 levels. -40 -8 -4 0 4 8 12 16 -8 -4 0 4 8 12 16 -40 • The rate of credit expansion in emerging markets slowed significantly in the aftermath of the house Credit price busts. In part, this is because a number of 20 16 15 emerging market economies experienced a credit 12 boom in the run-up to the financial turmoil.4 10 8 Credit growth in most emerging markets has 5 4 started to accelerate recently, and in one group of 0 economies credit is very buoyant once again. -5 0 -10 -4 4Following Mendoza and Terrones (2008), credit booms are -8 -4 0 4 8 12 16 -8 -4 0 4 8 12 16 defined as excessive real credit expansions above trend. Some Source: IMF staff calculations. of the economies that experienced a boom during 2007–08 1Including ongoing busts in the United States and Spain. include India, South Africa, and Venezuela. Hong Kong SAR is currently experiencing a credit boom, and China is near boom territory. (There is also evidence that several eastern Financial markets in advanced and emerging European economies and Nigeria, which are not included in market economies also experienced sharper swings the sample of emerging market economies, also experienced a in this cycle compared with previous cycles. Figure credit boom.)44 International Monetary Fund | April 2011

CHAPTER 1 GLOBAL PROSPECTS AND POLICIESBox 1.1 (continued)Why Did This Cycle Differ from Previous Cycles? In the run-up to the global financial crisis (that Two main factors contributed to the difference is, 2003–07), however, financial cycles were morebetween this cycle and previous cycles. First, in this synchronized across economies, particularly in creditcycle, an unusually large number of countries experi- and equity markets.6 This could reflect a varietyenced either a house price contraction or bust at the of factors, including the growing importance ofsame time. Data through the third quarter of 2010 global factors in determining financial fluctuations,indicate that virtually all 21 advanced economies the growing role of large international financialexperienced a price contraction5 and that five econo- institutions, and increased international financialmies have experienced (Denmark, New Zealand, integration.United Kingdom) or are experiencing (Spain, United These are some additional key findings:States) a house price bust. The closest historical • Equity markets in advanced and emergingepisode to the current one was observed in the early market economies are highly synchronized, but1990s. A key difference from the past, however, is housing markets are less so. These findings arethat this is the first time the United States, which consistent with the notion that equity marketsaccounts for the lion’s share of global financial trans- are more closely integrated internationally andactions, has experienced a house price bust. housing markets are less integrated but not Second, the degree of financial market synchro- independent of each other. The latter reflects thenization across countries was higher this time. The fact that, even though housing is the quintessen-cross-country synchronization for a financial variable tial nontradable asset, the key determinants ofcan be measured with a concordance index, which house prices (such as income and interest rates)shows the fraction of time the variable is in the same do tend to move together internationally.cyclical phase in two economies. The historical analy- • Credit markets are strongly synchronized acrosssis examines the nature and interaction of financial advanced economies and between advanced andcycles for 21 advanced economies and 23 emerging emerging market economies. However, theymarket economies using quarterly data over 1960– are less synchronized between emerging market2007. The results are set out in Table 1.1.1. economies. This may reflect the strong cross- As shown, house prices, equity prices, and credit border linkages of banks in advanced economiesare in the same cyclical phase at least half the time. and their important role in emerging market economies. In addition, credit shocks originat- 5A few of these house price contractions, including in ing in large advanced economies, such as theCanada, Greece, and Japan, are ongoing and are short of United States, have a significant effect on creditbeing categorized as price busts. 6These results are not driven by the experience in emerging conditions in emerging markets. In the run-Europe, which is highly financially integrated with western up to the financial crisis, credit markets acrossEurope, because these economies are not included in the advanced and emerging market economies weresample due to a lack of data. particularly synchronized, reflecting in part Table 1.1.1. Cross-Country Financial Market Synchronization Advanced and Emerging Market Advanced Economies Emerging Market Economies Economies House Prices 0.59 0.49 0.50 2003–07 0.74 0.49 0.60 Equity Prices 0.71 0.62 0.61 2003–07 0.90 0.80 0.81 Credit 0.74 0.48 0.65 2003–07 0.92 0.83 0.87 Source: IMF staff estimates. Note: The reported statistics correspond to the median of the country averages. International Monetary Fund | April 2011 45

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERY Box 1.1 (continued) accommodative monetary conditions, including More immediately, financial markets in emerg- low interest rates in advanced economies. ing market economies have rapidly recovered from the adverse impact of the recent house price busts Implications for Policy in advanced economies. Fueled by accommodative In the past, macroeconomic and prudential macroeconomic policies and strong capital inflows, policies were based primarily on domestic consider- house and equity prices in these economies are ations. The much greater synchronization of finan- buoyant and, in some cases, have already surpassed cial and housing markets evident in this cycle means precrisis levels. The authorities need to carefully that surveillance and domestic policies need to take monitor these developments, consider tightening much greater account of international developments macroeconomic policy, and strengthen macropru- than in the past. It may not be sufficient to ensure dential regulation. that loans made to residents by domestic financial In contrast, credit and housing markets in institutions are prudently managed and that the advanced economies are still weak, which is typical domestic housing market is sound. In the future, following house price busts. Action to accelerate policymakers may need to be aware of developments mending of household balance sheets and bank in geographically distant financial markets and take restructuring would help end the ongoing house action to protect their financial institutions from price downturns and busts and improve credit risks emanating from these markets. conditions.46 International Monetary Fund | April 2011

CHAPTER 1 GLOBAL PROSPECTS AND POLICIESBox 1.2. World Economic Outlook Downside Scenarios The scenarios presented here use the IMF’s Global in emerging Asia excluding China, 3 percent inIntegrated Monetary and Fiscal Model (GIMF) to the United States, and 2.5 percent in the remain-consider the possible implications for the world out- ing countries.1 Estimates of potential output inlook if potential output in some regions of the world the euro area and Japan are assumed to be broadlyis overestimated in the baseline forecast. Although correct. Where applicable, both the initial start-there is general consensus that potential output is ing points and the rates of growth over the WEOnow lower than projected before the recent financial forecast horizon contain errors. It is assumed thatcrisis, there is a risk that the downward revisions were starting point errors at end-2010 are approximatelynot large enough. The scenarios consider plausible 1.5 percent in the United States and the remainingmisperceptions of the current level of potential out- countries and 2 percent in China and emerging Asiaput and its growth over the WEO forecast horizon excluding China. The remaining errors arise fromin the United States, emerging Asia, and some other overestimating potential output growth for each yearemerging economies. The results illustrate how these of the forecast horizon. This implies errors in themisperceptions could lead to notably higher infla- annual growth rate of potential output of roughlytion in the near term and sharply lower growth and ¾ percentage point in China, ½ percentage point inincreasing external imbalances once policymakers and other emerging Asian economies, and ¼ percent-markets recognize the error. age point in the United States and the remaining Two alternative scenarios are considered. In the countries. It is assumed that no one recognizes thefirst, the implications of the policy errors associ- error until 2013.2ated with the overestimation of potential output In the first scenario, once policymakers recog-are simply greater macroeconomic volatility as the nize the error, monetary policy must be tightenedeconomies affected converge to the true level of sharply to return inflation to target. Markets alsopotential output. In the second, the policy errors respond and drive lending rates up by an additionalare more costly. The initial acceleration in inflation amount that is roughly proportional to the mag-becomes more entrenched in expectations, and a nitude of the misperception about supply capacity.more prolonged period of below-potential growth is Essentially, the realization that monetary conditionsrequired to re-anchor inflation expectations. have been excessively loose for an extended period Estimating sustainable economic output from his- raises concerns about underlying asset quality. Con-torical data is difficult in the best of times. However, sequently, the scenario incorporates temporary butit is even more challenging when the most recent persistent increases in private market interest ratesdata contain a boom-bust episode like the one the of an additional 150 basis points in China, 100global economy just endured. Estimates of the cur- basis points in the United States and emerging Asiarent level of potential output for many economies excluding China, and 50 basis points in the euromay not have fully accounted for the extent of area and the remaining countries (Figure 1.2.1).capital destruction wrought by the financial crisis In the first two years, real GDP grows accord-or its impact on structural unemployment. Pro- ing to the baseline forecast. However, given thejected potential output growth rates may be overly misperception of supply capacity, demand pressuresoptimistic, assuming that too much of the growth emerge in many regions of the world, and inflationmomentum over the past decade reflected underly- 1The block of remaining countries includes all the worlding fundamentals rather than being symptomatic of economies except the United States, the euro area, Japan,the financial excesses that eventually led to the crisis. China, and emerging Asia. In these scenarios it is assumed that the baseline 2An alternative approach would be to have policymakersforecast overestimates the level of potential output learn gradually about their misperceptions regarding the levelin 2015 by roughly 6 percent in China, 4 percent of potential output and start to tighten policy prior to 2013. If this were the case, then real GDP would turn out to be The main author of this box is Benjamin Hunt. Mika below the baseline prior to 2013, and the subsequent macro-Kortelainen and Stephen Snudden contributed. economic volatility would be reduced. International Monetary Fund | April 2011 47

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERY Box 1.2 (continued) exports. Even though rising inflation would signal Figure 1.2.1. WEO Downside Scenario 1: the potential output error to the Federal Reserve, Implications of Overestimating Potential Output slow recovery in the labor market coupled with an (Percentage point difference from baseline) overly optimistic view of the level for structural unemployment could prevent a timely adjustment Real GDP growth Current-account-to-GDP ratio in monetary conditions. Competitiveness concerns Core inflation in other regions of the world could lead to conditions remaining too loose there also, despite high 2 United States China 2 inflation. 1 1 Policymakers and markets do not recognize the 0 0 true level of potential output and its future path -1 -1 until 2013. This leads to tightening in monetary -2 -2 policy rates and additional increases in private -3 -3 market interest rates. Higher interest rates, recog- -4 -4 nition of weaker future income growth, and the -5 -5 consequent fiscal adjustment would all contribute 0 1 2 3 4 5 0 1 2 3 4 5 to a sharp slowdown in private consumption and 2 Emerging Asia Remaining Countries 2 investment growth. Real GDP growth declines 1 1 in 2013 by almost 4 percent in China, 3 percent 0 0 in other emerging Asian economies, and roughly -1 -1 2 percent in the United States and the remaining -2 -2 countries. The declines in growth are much milder -3 -3 in the euro area and Japan. Growth remains notably -4 -4 below the WEO baseline in 2014, but returns close to the baseline by 2015. The sharp slowdown in -5 -5 0 1 2 3 4 5 0 1 2 3 4 5 growth is sufficient to return inflation close to the baseline by 2015. 2 Euro Area Japan 2 Under this scenario, global imbalances would 1 1 widen further. Economies that already have high 0 0 surpluses (China and other emerging Asian econo- -1 -1 mies) experience an improvement in their cur- -2 -2 rent account balances because aggregate demand -3 -3 adjustment is largest in those regions. As consump- -4 -4 tion and investment demand slow rapidly, import -5 -5 growth falls sharply, leading to a rising trade 0 1 2 3 4 5 0 1 2 3 4 5 balance. In the United States and the remaining Source: Global Integrated Monetary and Fiscal Model countries, current accounts are largely unchanged simulations. as weaker import growth broadly matches the pace of slowing export growth. For the euro area and rises above the baseline forecast. It rises most sharply Japan, with no required adjustment in domestic in China and other emerging Asian economies, but demand, weaker trading partner growth trans- it also rises in the United States and the remaining lates to slower export growth, and their current countries. Although not explicit in the analysis, it is accounts deteriorate. likely that the demand and inflation pressures would In the second scenario, the initial burst in infla- be most acute in the emerging market economies tion becomes more entrenched in expectations, which contained within the block of remaining countries, is conceivable in a global environment where high notably those heavily dependent on commodity and rising commodity prices are likely to be fueling48 International Monetary Fund | April 2011

CHAPTER 1 GLOBAL PROSPECTS AND POLICIESBox 1.2 (continued)headline rates well above recent historical experience. Figure 1.2.2. WEO Downside Scenario 2:In addition to more persistent high inflation, it is Implications of Overestimating Potential Outputassumed that market concerns over asset quality fol- with Sticky Inflationlowing the boom are more acute. Consequently, once (Percentage point difference from baseline)policymakers recognize the error and tighten policyrates, markets drive lending rates up further than Real GDP growthin the first scenario. Market interest rates rise above Current-account-to-GDP ratio Core inflationpolicy rates by an additional 300 basis points in China,200 basis points in the United States and emerging 2 United States China 2Asia excluding China, and 100 basis points in the euro 1 1area and remaining countries (Figure 1.2.2). 0 0 Again the scenario assumes that in the first two -1 -1years GDP growth rates match those in the baseline, -2 -2but with potential output lower than expected, -3 -3excess demand pressures drive inflation above the -4 -4paths in the baseline. Once monetary policymakers -5 -5and markets recognize the error in 2013, the larger 0 1 2 3 4 5 0 1 2 3 4 5response in interest rates leads to a sharper slow-down in growth. The slowdown is most dramatic in 2 Emerging Asia Remaining Countries 2China, where GDP growth falls by roughly 5 per- 1 1centage points, followed by emerging Asia, where 0 0growth declines by almost 4 percentage points. -1 -1Growth falls by close to 3 percentage points in the -2 -2United States and by just over 2 percentage points -3 -3in the remaining countries. The greater persistence -4 -4in inflation means that interest rates must remain -5 -5higher for longer to keep GDP growth rates con- 0 1 2 3 4 5 0 1 2 3 4 5siderably below baseline in 2014 and 2015. Despite 2 Euro Area Japan 2substantial excess supply opening up in these econo-mies, inflation has not returned to target by the end 1 1of the WEO forecast horizon, implying that growth 0 0would need to be maintained below its potential -1 -1rate beyond 2015. Not surprisingly, with real activ- -2 -2ity more adversely affected by the misperception of -3 -3the level of potential output in this scenario, global -4 -4imbalances widen even further. -5 -5 0 1 2 3 4 5 0 1 2 3 4 5 For policymakers, these scenarios illustrate howplausible errors in estimating potential output Source: Global Integrated Monetary and Fiscal Modelcan lead to considerable volatility in growth and simulations.inflation and a widening of global imbalances ifthe error is only slowly recognized. Further, shouldhigh inflation become entrenched in expectations, and should be prepared to revise those estimatessignificant permanent losses in real GDP would regularly. For emerging economies already exhibit-be required to reestablish low and stable inflation. ing signs of overheating, competitiveness concernsPolicymakers should look carefully to core inflation should be of secondary importance. Containingoutcomes to inform their estimates about underly- inflation pressures early could substantially reduceing potential output and structural unemployment future economic volatility. International Monetary Fund | April 2011 49

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERY Box 1.3. International Spillovers and Macroeconomic Policymaking The duration and severity of the Great Recession approximation of the optimal policy.1 If the theory induced a variety of unconventional policy responses is ambiguous, quantitative assessments are even in a number of countries. This is especially true more so, if only because there have been so few. in the United States, where an alphabet soup of To illustrate, consider the policy choices avail- liquidity support programs has been complemented able to the monetary authority of a small economy by two rounds of so-called quantitative easing. The operating in a world that is dominated by a much latest round, dubbed “QE2” by some, has been met larger economy. In order to encompass the rigidities with opprobrium in some circles, in part because and imperfections in exchange rate pass-through the Federal Reserve’s aggressive attempts to return emphasized by the literature to date in making a employment to normal levels are seen as damaging case for coordination, we use a version of the IMF’s to the interests of smaller economies, particularly Global Economic Model (GEM) used in Laxton those that do not consider themselves to have and Pesenti (2003).2 Both economies are assumed to substantial excess supply. Out of this experience implement monetary policy by means of a Taylor- have come renewed calls for international policy type rule, the most general form of which is coordination. This box takes a selective look at this R = αR Rt–1 + (1 – αR)(rr* + πt ) + αy yt  issue, focusing on monetary policy coordination but + απ(πt – π*) + αe(Δet – Δe*),  with a few words on fiscal policy at the end. To presage the results, policy coordination can where R is the nominal policy rate; π is (four-quar-  deliver outcomes that are superior to those of ter) inflation; Δe is the change in the (log of the) policies that are driven only by national interests. real exchange rate; and rr* is the equilibrium real However, it turns out that the case for systematic interest rate. For this exercise, rr* and the target rate coordination of monetary policy is not as strong as of inflation, π*, are taken as constants and normal- one might think, although the range of models in ized to zero; some implications of this assumption which this question has been analyzed is still quite are discussed below. limited. More research is clearly warranted. By Assume that the large economy does not consider contrast, the case for coordination is easier to make the effects of its policy decisions on the small for fiscal policy. economy—which is natural given the relative sizes Popular discussion suggests that the argument of the two economies. One way to characterize the in favor of policy coordination—in particular for critique of recent U.S. monetary policy is to con- large economies or collections of small ones—is sider policy rules for the large economy that place a irrefutable. After all, in times of widespread defi- large coefficient on its output gap, sacrificing other ciency in domestic demand, all economies have an objectives in order to rapidly return economic activ- incentive to “export their way out of recession,” ity to equilibrium levels following shocks. With this even if the arithmetic of trade accounts makes that an impossible feat. The economic literature, 1The case for the coordination of monetary policy usually however, is not nearly so clear-cut. In the context hinges on rigidities that slow down the pass-through of for- of monetary policy, Obstfeld and Rogoff (1995) eign shocks into domestic aggregate price levels. Incomplete laid down a marker by showing in a simple two- or delayed exchange rate pass-through hinders the adjustment country model that policies that are “self-oriented” of the real wage to its equilibrium level, inducing fluctuations are difficult to beat. Subsequent contributions to in employment that would otherwise not occur. An incomplete sampling of references might include Betts and Devereux the literature have mitigated this result, but argu- (2000), Pappa (2004), and Corsetti and Pesenti (2005). ably not in a way that undermines the case for self- 2 GEM is a linearized microfounded, two-country model oriented monetary policy, at least as a reasonable with tradable and nontradable goods, monopolistic competi- tion in labor and some goods markets, sticky prices, and incomplete pass-through stemming both from the presence of intermediate goods and from adjustment costs. See Laxton The author of this box is Robert Tetlow. and Pesenti (2003) for details.50 International Monetary Fund | April 2011

CHAPTER 1 GLOBAL PROSPECTS AND POLICIESBox 1.3 (continued)in mind, the exercise below encompasses this andother policy stances by allowing the coefficient on Figure 1.3.1. Optimized Exchange Rate Coefficient and Relative Loss as a Function ofthe large economy output gap, αy , to vary from zero Home Output Gap Response1to 3.3 The small economy takes the large economy’spolicy rule as given and then chooses the coefficient Foreign country exchange rate coefficienton the exchange rate term in the small-economy Relative loss (percent)policy rule, holding other coefficients constant tominimize the following loss function:4 0.10 L = Σ∞ y2 + (πt+i – π*)2 + – (ΔRt+i)2. i=0 t+i  1 2 If the large economy’s policy choice is harmful tothe small economy’s performance, and if controllingthe exchange rate is helpful for offsetting the large 0.05economy’s policy choices, αe for the small economywill differ substantially from zero, and the effecton the small economy’s economic performance, asmeasured by its loss function, will be large.5 0.00 The results of this exercise are summarized in 0.0 1.0 2.0 3.0 Home country output-gap coefficientFigure 1.3.1. The coefficient on the large economy’soutput gap is indexed on the horizontal axis. Focus- Source: IMF staff calculations.ing first on the blue line, there are several observa- 1All other policy rule coefficients held fixed.tions of note. First, the downward slope of the lineshows that as the large economy places increasingimportance on combating output fluctuations, the economy to respond to the exchange rate, at leastsmall economy’s exchange rate coefficient falls; only through standard monetary policy channels. Second,when the large economy pays almost no (direct) the quantitative implications for monetary policyattention to output is there a reason for the small with respect to the exchange rate are not very large: at no time does the feedback coefficient rise above 3For a model of this class, α = 3 is a very large coefficient. 0.1.6 These results suggest that large and small yFor the home economy, the baseline parameters for the policy economies’ objectives are largely complementary:rule are αR = 1, απ = 0.7, αy = varying, and αe ≡ 0. when the large economy acts to stabilize real activ-Results are similar for different parameterizations of the home ity within its own borders, it reduces what wouldeconomy rule and, in particular, for αe ≠ 0. For the foreign otherwise be negative demand spillovers to the restcountry, αR = 0.97, απ = 0.7, αy = 0.4, and αe = optimized.The foreign country’s coefficients are very close to the optimal of the world. The fact that the coefficient on thecoefficients, conditional on no feedback on the exchange rate. exchange rate in the small economy’s policy rule is 4Formally, the optimization is done numerically by minimizing never very large is a reminder that stabilizing infla-the loss function, subject to the (linear) model; the form of the tion, as the economy does in all cases here, goes apolicy rule; the home economy model, including its policy rule; considerable way toward stabilizing output, regard-and the variance-covariance matrix of stochastic shocks. This isthe same loss function that is used in Laxton and Pesenti (2003). less of the feedback coefficient on the gap. 5The experiment conducted here is a restricted version of onewhere all four parameters of both economies’ policy rules areoptimized economy by economy, defining what is known as a 6Although this exercise was carried out for particular rules forNash strategy in Taylor rules, or jointly using a weighted average both economies, the basic conclusions are the same for reasonableof the two economies’ loss functions, defining a cooperative strat- specifications. However, the results will differ if the parameteriza-egy in Taylor rules. This broader exercise proved to be numeri- tion of the policy rule for the foreign economy is well away fromcally problematic for a model as large and complex as the GEM; optimal, when the exchange rate term is omitted. Under such cir-however, the experiments that were feasible suggested that the cumstances the optimized exchange rate term will crudely proxysame conclusions as described in the text would be forthcoming. for the inappropriate feedback terms on output or inflation. International Monetary Fund | April 2011 51

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERY Box 1.3 (continued) Now consider the red line. The line shows the the model and all its features, including linearity incremental cost, in percent (right scale), of omit- and rational expectations. These can be important. ting the exchange rate term altogether. Given how The linear analysis carried out here, for example, small the feedback coefficients are on the exchange ignores the effective lower bound on nominal rate term, it is probably not surprising that the loss interest rates, a binding constraint on some author- from eschewing feedback on the exchange rate is very ities at the moment. And the extant literature has small, never larger than 0.1 percent. The upshot, in considered only a limited range of distortions that this context at least, is the conclusion of Obstfeld and might provide a case for cooperation. Undoubt- Rogoff (2002): two economies practicing inward- edly, there is a need for further research on these looking policies will produce policy outcomes that and other issues. Nevertheless, the results shown are quite good, even if they are not quite optimal. here—which are consistent with the economic lit- It is important to note that it is not that spillovers erature—do suggest that the case for coordination from the large economy to the small economy are of monetary policy is limited, at least under nor- inconsequential. Rather, a properly designed mon- mal circumstances and with conventional models. etary policy, focused narrowly on key macroeconomic We have seen that the case for monetary policy objectives, insulates the small economy well. It does coordination is not as obvious as might be expected. this by aligning private agents’ expectations with poli- Does this finding generalize to fiscal policy? It was cymakers’ goals; the former becomes an instrument, noted above that the analysis here was conducted of sorts, of the latter.7 taking the equilibrium real interest rate, rr*, as There are, of course, some caveats. First, the a constant. This is a reasonable assumption for results depend on the monetary authorities know- economies with a record of stable monetary policy. ing not only their own economy’s model but that Under such circumstances, the conduct of monetary of the other economy as well.8 Second, the opti- policy is a relatively simple exercise in stabilizing the mization exercise was carried out for a computed economy around a given steady state. The situation variance-covariance matrix of shocks, but if the for fiscal policy can be quite different. Although it is shocks during a particular episode turn out to be beyond the scope of this box to demonstrate, fiscal atypical, the prescribed policy response might be policy can affect the equilibrium real interest rate, inappropriate. This is true particularly if the shocks the sustainable level of output, and the neutral level in question alter the dynamic structure of the of the policy instrument, sometimes in ways that are economy.9 Third, these results are conditional on difficult to measure. Fiscal policy, therefore, involves balancing gains or losses in the short term against 7Specifically not included in the class of policy regimes cov- permanent but deferred losses or gains in the long ered here is an exchange rate target, de facto or de jure. Under term as the economy approaches its new steady state. an exchange rate target, the foreign economy inherits which- So if an economy’s monetary policy is already broadly ever monetary policy the home economy adopts. Box 1.1 of reasonable, the stakes when it comes to adjusting fis- the April 2010 World Economic Outlook explores exchange rate targeting regimes during the recent crisis. cal policy are generally higher. Moreover, fiscal policy 8How serious this misspecification will be depends on the in large economies, or collections of small ones, circumstances. It is worth noting that the apparent misspecifi- can affect the world real interest rate and hence the cation of the variance-covariance matrix of shocks is often a steady state of other economies. It seems reasonable symptom of a more generalized misspecification of the under- to conclude, therefore, that the case for coordination lying model. Frankel and Rockett (1988) provide a quantitative assessment of what can go wrong in policy coordination of macroeconomic stabilization policies is stronger for when decision makers’ models are misspecified. fiscal policy than for monetary policy. 9For example, shocks that are larger and more persistent than normal could elicit macroeconomic outcomes that cause private agents to doubt the monetary or fiscal policy regime. ment of rational expectations equilibrium. For an example Coordinated policies could be used to ensure the reestablish- along these lines, see Eusepi and Preston (2008).52 International Monetary Fund | April 2011

CHAPTER 1 GLOBAL PROSPECTS AND POLICIESBox 1.4. Did the Plaza Accord Cause Japan’s Lost Decades? The rebalancing debate has sparked renewed inter- economy in recession and the exchange rate appre-est in Japan’s experience since the 1980s. Some argue ciating rapidly, the authorities were under consider-that this is a cautionary tale, exemplifying the dangers able pressure to respond. They did so by introducingof reorienting economies through currency appre- a sizable macroeconomic stimulus. Policy interestciation (People’s Daily, 2010). They claim that the rates were reduced by about 3 percentage points, aappreciation of the yen after the Plaza Accord forced stance that was sustained until 1989. A large fiscalthe authorities to introduce an offsetting macroeco- package was introduced in 1987, even though a vig-nomic stimulus, which then led to an extraordinary orous recovery had already started in the second halfasset price boom followed by an extraordinarily pain- of 1986. By 1987, Japan’s output was booming, butful bust. Japan was one of the world’s fastest-growing so were credit growth and asset prices, with stockeconomies for three decades but has averaged only and urban land prices tripling from 1985 to 1989.1.1 percent real GDP growth since 1990, while Then, in January 1990, the stock price bubble burst.prices have steadily declined. Consequently, the size Share prices lost a third of their value within a year,of Japan’s economy today is about the same as in the and two decades of dismal economic performanceearly 1990s. The sequence of events is clear and strik- followed (Figure 1.4.1). Today, nominal stock anding. But there are reasons to doubt that it was truly land prices are back at their early 1980s levels, one-inevitable, whether the Plaza Accord was really the quarter to one-third of their previous peaks.direct cause of Japan’s “Lost Decades.” The critical question is whether this sequence was inevitable. In other words, did the apprecia-What Happened? tion force Japan to introduce a powerful stimulus The events began in September 1985, when to sustain growth, which then triggered a bubble,delegates from the G5 countries met at the Plaza which caused the Lost Decades when it collapsed?Hotel in New York, declared the U.S. dollar overval- Let’s consider each step in turn.ued, and announced a plan to correct the situation.1The essence of the plan was that the main current Was Such a Large Stimulus Needed?account surplus countries (Japan and Germany) Studies suggest that, in fact, the monetarywould boost domestic demand and appreciate policy easing may have been excessive. Estimatestheir currencies. In effect, this agreement marked a by Jinushi, Kuroki, and Miyao (2000) and Leighmajor change in policy regime: the Federal Reserve (2010), among others, suggest that the policy ratewas signaling that after a long and successful fight was up to 4 percentage points too low duringagainst inflation, it was now prepared to ease poli- 1986–88 relative to an implicit Taylor rule basedcies, allow the dollar to decline, and focus more on the output and inflation outlook. Why, then,on growth. This signal was backed by coordinated did the central bank sustain such a policy? A keycurrency market intervention and a steady reduction reason is that current inflation remained reasonablyin U.S. short-term rates. Accordingly, it triggered an well behaved, which led some economists to argueexceptionally large appreciation of the yen, amount- that soaring growth rates did not represent a cyclicaling to 46 percent against the dollar and 30 percent boom but rather a “new era” of higher potentialin real effective terms by the end of 1986. (The growth. This growth was particularly gratifyingdeutsche mark appreciated similarly.) because it was led by domestic demand, a key com- As a result, Japan’s export and GDP growth mitment under Plaza.essentially halted in the first half of 1986. With the But IMF reports at the time suggest another factor was also at work. The authorities worried that higher interest rates would further strengthen the The main authors of this box are Joshua Felman andDaniel Leigh. yen and feared that appreciation would eventually 1The G5 comprises France, Germany, Japan, the United have serious effects on the economy. In the end,Kingdom, and the United States. external demand did indeed diminish. But it did International Monetary Fund | April 2011 53

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERY Box 1.4 (continued) not collapse. Real exports continued to grow in the five years after Plaza, by an average of 2½ percent a Figure 1.4.1. Japan: Selected Macroeconomic year (half the rate of the previous five years), while Indicators the current account surplus diminished by a moder- Nominal GDP, Yen per U.S. Dollar, ate 2 percentage points of GDP. (Similarly, Germa- 1980–88 600 1970–2009 100 ny’s currency appreciation failed to derail its export (trillions of yen) (inverted scale) or GDP expansion, even with a smaller monetary 500 Plaza Accord 150 response.) Put another way, excessive stimulus was 400 adopted in part because there was excessive concern 300 200 about the impact of appreciation. Plaza Accord 200 250 Did the Stimulus Cause the Bubble? 100 Although the monetary easing was certainly large, 0 1970 80 90 2000 09 1980 84 300 Jan. it is far from clear that it alone was responsible for 88 the asset price bubble. Chapter 3 of the October Interest Rate Policy, Land and Stock Prices 2009 World Economic Outlook and Posen (2003) 10 1984–92 1 (1981:Q1 = 100) 600 Estimated have examined the link between monetary policy 8 Taylor Stock price 500 and asset price booms in advanced economies over rule 400 the past 25 years. They conclude that policy easing 6 300 is neither necessary nor sufficient to generate asset 4 Actual call 200 price booms and busts. In Japan’s case, two other money rate elements seem to have played a large role. As Hoshi 2 Land price 100 Plaza Accord and Kashyap (2000) explain, financial deregulation 0 0 in the 1970s and early 1980s allowed large firms 1984 86 88 90 92: 1981 90 2000 10: Q4 Q3 to access capital markets instead of depending on Sources: Bank of Japan; Cabinet Office (Japan); Haver Analytics; bank financing, leading banks to lend instead to real and IMF staff estimates. estate developers and households seeking mortgages. 1For details on the estimation of the Taylor rule, see Leigh (2010). As a result, bank credit to these two sectors grew by about 150 percent during 1985–90, roughly twice as fast as the 77 percent increase in overall bank I accord) had not yet gone into effect. Moreover, credit to the private sector. Finally, because the dan- much of the collateral for loans was in the form gers of real estate bubbles were not well understood of real estate, whereas under the keiretsu system a in those years, the Japanese government did not significant portion of bank assets consisted of shares deploy countervailing regulatory and fiscal policies in other firms from the same group. So, when real until 1990. estate and share prices collapsed, the banking system was badly damaged. Did the Bubble’s Collapse Cause the Lost Decades? This underlying vulnerability was exacerbated by a The aftermath of the bubble proved extraordi- slow policy response. The authorities delayed forcing narily painful for Japan. But the collapse of a bubble banks to recognize the losses on their balance sheets does not inevitably have such powerful and long- and allowed them to continue lending to firms lasting effects. What was special about Japan’s case? that had themselves become insolvent, a process A key factor was the buildup of considerable lever- Caballero, Hoshi, and Kashyap (2008) call “zom- age in the financial system, similar to what occurred bie lending.” This process continued into the early in the United States before 2008. Tier 1 capital of 2000s, stifling productivity growth and prolonging Japanese banks in the 1980s was very low, much Japan’s slump. Why did the authorities not force lower than elsewhere, as global standards (the Basel faster restructuring? Possibly because restructuring54 International Monetary Fund | April 2011

CHAPTER 1 GLOBAL PROSPECTS AND POLICIESBox 1.4 (continued) Lessons for Rebalancing Today Figure 1.4.2. Japan and China: Balance Sheets and Export Content Calibrating a policy response to exceptionally large appreciations and movements in asset prices Balance Sheets Export Content: remains an extraordinarily difficult task. But some (percent of GDP) High-Tech Share of pointers can be gleaned from Japan’s experience. The 300 Exports 70 Corporate debt keys are to Household debt 60 250 • avoid an excessive macroeconomic response to 50 200 currency appreciations; 40 150 • use prudential policies to prevent vulnerabilities 30 from building up, especially in the form of leverage; 100 20 • address banking problems quickly if they do 50 10 materialize; and 0 Japan China Japan China 0 • provide significant macroeconomic support when (1980–85) (2003–08) (1980–85) (2003–08) banking systems and economies come under stress. An even broader lesson is that bubbles can prove Sources: Haver Analytics; and IMF staff estimates. dangerous. Accordingly, Japan has introduced a two- perspective framework for monetary policy, with one pillar focusing on price stability and the other lookingwould have required additional bank capital, which out for financial imbalances such as asset price bubbles.they were not in a position to provide in light of the But even as Japan’s experience offers lessons tostrong political backlash after an initial injection of countries considering rebalancing today, the directpublic capital in 1995. Consequently, the authorities parallels are limited. Most notably, circumstances inexercised forbearance instead. China today differ from those in Japan in the 1980s The postbubble slump may also have been exac- in ways that should help it avoid Japan’s disappoint-erbated by the macroeconomic policy response and ing outcomes (Figure 1.4.2). First, the leverage ofadverse external shocks. Some argue that premature households, corporations, and the government inmonetary tightening and the lack of a clear com- China is lower now than it was in Japan before themitment to raising inflation led to unduly high real bubble (N’Diaye, 2010), and the risk of excessiveinterest rates (Ito and Mishkin, 2006; Leigh, 2010). borrowing may thus be smaller. Second, as ChapterIn addition, the tightening of fiscal policy in 1997 4 of the April 2010 World Economic Outlook andmay have undercut the nascent 1995–96 recovery Igan, Fabrizio, and Mody (2007) find, climbing the(Posen, 2003; Corbett and Ito, 2010). Finally, quality ladder helps offset the impact on growth ofadverse external shocks played a role, including the currency appreciation, and China has more room1997–98 Asian financial crisis. to climb the export quality ladder than Japan did. In sum, Japan’s experience shows that currency (At the same time, the impact on labor-intensiveappreciation does not, in fact, inevitably lead to industries may be greater.) Third, Japan had a floating“lost decades.” The appreciation did not inevita- exchange rate regime in the 1980s, but China hasbly require such a large macroeconomic stimu- a managed exchange rate supported by vast foreignlus. The stimulus did not inevitably lead to the currency reserves and strong restrictions on capitalbubble. Nor did the bubble’s collapse inevitably inflows. This difference in currency regimes shouldlead to the Lost Decades. Instead, it was the par- help China avoid the sharp appreciation observed inticular combination of circumstances and choices Japan. Most important, China should be able to reapthat led to that result. the benefits of learning from Japan’s experience. International Monetary Fund | April 2011 55

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1 2 HAPTERCHAPTER COUNTRY AND REGIONAL PERSPECTIVES The global economy is now two years into its recovery. From regions where credit is reaccelerating and signs of the outset, it was expected to be a multispeed recovery—the overheating are emerging. Meanwhile, the economies April 2009 World Economic Outlook projected that the at the center of the recent crisis, the United States economies that would be growing the fastest by 2011 were and Europe, have substantial excess capacity. These those that had avoided large precrisis imbalances, had seen divergences have important implications for the the smallest output collapses during the crisis, and had the outlook, risks, and policy priorities in each region. most room for policy maneuvering after the crisis. Two years Therefore, this chapter highlights the extent to which later, that picture is broadly unchanged, but the contours regions diﬀer in their cyclical positions. of the recovery are clearer (Figure 2.1). Some advanced Similarly, there are large disparities in some economies have significant output gaps and elevated economies’ external positions. Past issues of the World unemployment rates; many low-income countries are grow- Economic Outlook have stressed the need for exter- ing at rapid but sustainable rates; and there are signs of nal rebalancing in some regions—most notably the overheating in a number of emerging market economies. United States and emerging Asia—to reduce global vulnerabilities. This chapter revisits this topic to highlight, where relevant, the extent to which regions The uneven nature of this recovery can be seen in diverge in their external (current account balance) the output gaps across regions (Figure 2.2). Emerging positions. Asia and much of Latin America are now operating The chapter begins by assessing the outlook and key close to potential, and there are economies in these policy challenges in the regions where large output Figure 2.1. Global Average Projected Real GDP Growth during 2011–12 (Percent) Below 0 Between 0 and 2 Between 2 and 4 Above 4 Insufficient data Source: IMF staff estimates. Note: Projections are not provided for Libya due to the uncertain political situation. International Monetary Fund | April 2011 59

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERY gaps persist—the United States and Canada, Europe, and the Commonwealth of Independent States (CIS). It then examines regions where output gaps are closing or have already closed—Asia, Latin America and the Figure 2.2. Output Gaps1 Caribbean (LAC), sub-Saharan Africa (SSA), and the (Percent of potential GDP) Middle East and North Africa (MENA). 6 Recovery Proceeds in the United States 4 Europe The U.S. economy continues to recover, with easing 2 financial conditions supporting private final demand in the 0 face of higher commodity prices (Figures 2.3 and 2.4). Job -2 creation has recently accelerated, but the pace of improve- -4 ment in the labor market remains disappointing consider- USA+CAN ing the size of the job losses during the decline. A further -6 rebalancing from domestic to external demand would add -82000 02 04 06 08 10 12 to growth and help to close the large U.S. output gap. Following a burst of strong growth driven by 6 inventory restocking in late 2009 and early 2010, 4 economic growth slowed but then strengthened again Emerging 2 in the second half of 2010. This strengthening was Asia supported by private final demand, and by the fourth 0 quarter consumer spending was rising at its fastest LAC -2 pace in five years. Although overall credit growth -4 remains weak and household deleveraging Advanced -6 continues, financial conditions have generally Asia -8 improved—corporate borrowing rates remain very2000 02 04 06 08 10 12 low, and tight bank lending conditions are now starting to ease not just for large firms but for small 6 CIS and medium-size firms. Reflecting the pickup in 4 economic activity and supported by unconventional MENA2 2 monetary easing, equity markets have recovered SSA 0 about two-thirds of the capitalization lost during the -2 crisis. This has helped rebuild consumer confidence, which is still being held down by labor and housing -4 headwinds. -6 Recovery in the labor market remains lackluster. -8 After shedding more than 8½ million jobs in 20082000 02 04 06 08 10 12 and 2009, the labor market has added just under Source: IMF staff estimates. 1½ million jobs since the trough, barely sufficient to 1Advanced Asia: Australia, Japan, and New Zealand; CIS: Commonwealth of Independent keep up with the growth of the working-age popula- States, Georgia, and Mongolia; LAC: Latin America and the Caribbean; MENA: Middle East and North Africa; SSA: sub-Saharan Africa; USA+CAN: United States and Canada. Regional tion. The employment-population ratio is thus largely aggregates are computed on the basis of purchasing-power-parity weights. 2Excludes Libya for the projection years due to the uncertain political situation. unchanged since the start of the recovery. About a third of the decline in the unemployment rate since October 2009—to 8.8 percent in March—is attribut- able to a decline in labor force participation, which now stands at its lowest level in a quarter century.60 International Monetary Fund | April 2011

CHAPTER 2 COUNTRY AND REGIONAL PERSPECTIVESFigure 2.3. United States and Canada: Average Projected Real GDP Growth during 2011–12(Percent) Below 0 Between 0 and 2 Between 2 and 4 Above 4 Insufficient data Covered in a different map Source: IMF staff estimates.Long-term unemployment and broader measures of 2.1). The fiscal package approved in mid-Decemberunderemployment—including the share of workers implies slightly more than a ½ percentage point addi-involuntarily working part-time or only margin- tion to growth this year, although recent proposalsally attached to the labor force—remain well above to curb federal spending would reduce the overallhistoric highs. The crisis may also have increased impulse from federal fiscal policy. The drag on 2011structural unemployment in the United States, growth from oil price increases largely offsets thebecause severe sectoral and regional shocks created boost from the Federal Reserve’s unconventional poli-mismatches between labor skill supply and demand. cies and from stronger net exports. Unemployment isIMF staff research shows that, historically, the nega- projected to remain high, declining only moderatelytive effect of skill mismatches on unemployment rates to about 7¾ percent in 2012.is exacerbated by depressed housing markets, a key The risks to the outlook remain tilted to the down-aspect of the recent crisis.1 side. The external environment continues to pose The U.S. economy is projected to grow by 2¾ tail risks. Renewed financial turmoil in the euro areapercent and 3 percent in 2011 and 2012, respectively, could substantially tighten financial conditions andwith gradually firming private final demand offsetting weaken global demand. And a spike in oil and com-the waning support from federal fiscal policy (Table modity prices, possibly due to continuing tensions in the Middle East and North Africa, could dampen 1See Dowling, Estevão, and Tsounta (2010); and Estevão and confidence and weaken consumer spending. On theTsounta (2011). domestic front, house prices could decline by more International Monetary Fund | April 2011 61

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERY than expected, given the large shadow inventory of distressed properties, with adverse effects on house-Figure 2.4. United States: Gaining Traction hold and financial balance sheets. There are, however, a number of upside risks to the outlook. Healthy corporate balance sheets could support strongerThe recovery is starting to take hold, as private consumption continues to accelerate,albeit slowly. And growth in 2011 will get a boost from the December fiscal package. hiring and capital investment if business confidenceQuantitative easing has helped fend off deflation pressure arising from a still-large improves. And private consumption, particularly ofoutput gap. But vulnerabilities remain: the labor and real estate markets remain weak,and fiscal vulnerabilities need to be addressed. durables, may surprise on the upside given pent-up demand. Contribution to Growth Impact of December Fiscal Given the substantial slack in the economy—the 8 (annualized quarterly percent Package (percentage point 2.5 output gap is estimated to remain above 3 percent change) difference in annualized 6 quarterly growth) 4 2.0 this year—inflation is expected to stay subdued, 2 1.5 with price increases of 2¼ percent this year and 1½ 0 1.0 percent next year. While food and, especially, energy -2 0.5 prices have risen, their share in the consumer basket -4 GDP 0.0 is small, and second-round effects are likely to be -6 growth -8 Consumption -0.5 minor because the economy is operating well below-10 Fixed investment Change in inventories -1.0 potential.-12 Net exports The sluggish pace of the economic recovery calls-14 -1.5 2007 08 09 10: 2011 12: Q4 Q4 for supportive macroeconomic policies, but fiscal room is becoming increasingly limited. In this con- 1 Output Gap 600 Labor Market 11 (percent of potential GDP) Unemployment rate text, the right policy mix for the United States is one 0 400 (percent, 10 of continued monetary accommodation alongside 200 right scale) 9-1 moves to put fiscal balances on a sounder footing.-2 0 8 A credible strategy to stabilize public debt in the-3 -200 7 medium term, and a down payment on fiscal consoli--4 -400 6 dation in 2011, are urgently needed.-5 -600 Change in 5 With output still significantly below potential, employment-6 -800 (thousands, 4 inflation persistently low, and the unemployment rate left scale)-7 -1000 2007 08 09 3 10 Mar. stubbornly high, continued monetary accommoda- 2004 06 08 10 12 11 tion is warranted. Although the Federal Reserve’s second round of quantitative easing is expected to Housing Market1 Fiscal Balance and Debt have only a modest effect on growth, it seems to have (price indices = 100 in (percent of GDP)200 2002:M1; housing starts in 2000 0 120 reduced perceptions of deflation risks; in the weeks thousands of units) following the news in August that the new round of Case-Shiller -2 110160 1600 Composite 20 -4 100 quantitative easing was imminent, inflation expec- FHFA120 1200 tations rose and long-term yields fell to new lows. -6 Gross 90 NAR public debt Long-term yields have since increased as signs of a Housing starts -8 (right scale) 80 80 (right scale) 800 strengthening recovery emerged and traders scaled -10 70 back their expectations of the extent of future asset 40 400 Net lending -12 or borrowing 60 purchases by the Federal Reserve. (left scale) Although some targeted fiscal measures are justifi- 0 0 -14 50 2007 08 09 Feb. 2004 08 12 16 11 able at this point given the weak state of labor and housing markets, the recent stimulus package delivers Sources: Haver Analytics; and IMF staff estimates. 1 FHFA: Federal Housing Finance Agency. NAR: National Association of Realtors. only a small growth dividend for its considerable budgetary cost. Also, the fiscal deficit is now projected to reach 10¾ percent this year—the largest62 International Monetary Fund | April 2011

CHAPTER 2 COUNTRY AND REGIONAL PERSPECTIVESTable 2.1. Selected Advanced Economies: Real GDP, Consumer Prices, Current Account Balance, andUnemployment(Annual percent change unless noted otherwise) Real GDP Consumer Prices1 Current Account Balance2 Unemployment3 Projections Projections Projections Projections 2010 2011 2012 2010 2011 2012 2010 2011 2012 2010 2011 2012Advanced Economies 3.0 2.4 2.6 1.6 2.2 1.7 –0.2 –0.3 –0.2 8.3 7.8 7.4United States 2.8 2.8 2.9 1.6 2.2 1.6 –3.2 –3.2 –2.8 9.6 8.5 7.8Euro Area4,5,6 1.7 1.6 1.8 1.6 2.3 1.7 –0.6 0.0 0.0 10.0 9.9 9.6Japan 3.9 1.4 2.1 –0.7 0.2 0.2 3.6 2.3 2.3 5.1 4.9 4.7United Kingdom4 1.3 1.7 2.3 3.3 4.2 2.0 –2.5 –2.4 –1.9 7.8 7.8 7.7Canada 3.1 2.8 2.6 1.8 2.2 1.9 –3.1 –2.8 –2.6 8.0 7.6 7.3Other Advanced Economies7 5.7 3.9 3.8 2.3 3.1 2.6 5.1 5.5 4.8 5.0 4.5 4.4MemorandumNewly Industrialized Asian Economies 8.4 4.9 4.5 2.3 3.8 2.9 7.1 6.3 6.0 4.1 3.6 3.6 1Movements in consumer prices are shown as annual averages. December–December changes can be found in Table A6 in the Statistical Appendix. 2Percent of GDP. 3Percent. National deﬁnitions of unemployment may differ. 4Based on Eurostat’s harmonized index of consumer prices. 5Current account position corrected for reporting discrepancies in intra-area transactions. 6Excludes Estonia. 7Excludes the United States, Euro Area, and Japan but includes Estonia.among the advanced economies—and gross debt of draft budget implies a very large near-term fiscalthe general government will likely exceed 110 percent withdrawal—a reduction of some 5 percentage pointsof GDP by 2016.2 Indeed, the United States stands of GDP in the federal structural primary deficit overout as the only large advanced economy where the fiscal years 2012 and 2013 on the basis of IMF staffcyclically adjusted fiscal deficit is expected to increase macroeconomic and policy assumptions—whichin 2011 compared with 2010 despite the ongo- will be challenging to implement, especially in aning economic recovery.3 The United States remains environment of weak growth and elevated unem-committed to meeting the G20 target of halving the ployment. Such an adjustment would be larger thandeficit between 2010 and 2013, but the high deficit any two-year adjustment since 1960 (the first yearthis year may make this difficult. for which data on structural balances are available), This unsustainable fiscal outlook calls for a down which strengthens the case for smoothing the fiscalpayment on fiscal consolidation this year. The pro- adjustment beginning in 2011 within a credibleposals recently put forward by the National Com- medium-term framework.mission on Fiscal Responsibility and Reform and Although the current account deficit is not ex-other analysts contain many useful ideas and provide pected to widen substantially in the coming years,comprehensive blueprints on which policymakers can deficits will persist—the medium-term current accountbuild. These proposed measures include reforms to deficit is projected to remain close to last year’s level, inentitlement programs, caps on discretionary spend- part because of insufficient fiscal adjustment. Shoulding, revenue-raising tax reforms, and strengthening much-needed fiscal consolidation take place in theof fiscal institutions. Meanwhile, the president’s coming years, this will help bring down external deficits. A more robust recovery will then require a larger 2The fiscal projections reflect IMF staff views on the economic contribution to growth from net exports to offset aoutlook (which are generally more pessimistic than the authorities’)and assessments of likely policies. Given the ongoing debate in smaller contribution from domestic demand.Congress, the IMF staff assumes more front-loaded (and deeper) Despite the restoration of financial stability, fragili-discretionary spending cuts than proposed in the president’s draft ties in the housing sector continue to weigh downbudget and delayed action on revenue-raising measures. 3The April 2011 Fiscal Monitor discusses the U.S. fiscal policy banks’ balance sheets, and there remain difficultstance in greater detail. challenges in implementing financial sector reforms. International Monetary Fund | April 2011 63

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERY The recent overhaul of financial system regulation to smooth the up-front fiscal adjustment are wel- and supervision has been encouraging, but imple- come, and the authorities have a sound and credible mentation will be the key test. Critical priorities will plan to return to budget surpluses beginning in fiscal be to implement a systemic approach to oversight, year 2015. Over the longer term, challenges from with stronger regulation (especially for systemically population aging and health care inflation require important institutions), greater transparency and further plans to cement fiscal sustainability. On the accountability in securities and derivatives markets, financial front, Canada’s supervisory and regulatory and close monitoring of the shadow banking sector. approach has been sound, and it has helped prevent The U.S. authorities have presented Congress with a the excesses that hurt other advanced economies dur- set of proposals to reform housing finance markets, ing the recent crisis. However, continued vigilance is as mandated by the Dodd-Frank Act. The recom- needed to maintain financial stability, particularly in mendations include winding down government- light of high concentration in the financial system, sponsored entities (Fannie Mae and Freddie Mac) substantial exposure to U.S. risks, and historically and crafting more focused housing policies, including high household debt levels. more explicit and targeted government support. The eventual reform will need to strike the right balance between delivering an appropriate level of explicit A Gradual and Uneven Recovery Is under Way government intervention and discouraging another in Europe cycle of overinvestment. In Europe, the recovery is proceeding modestly (Figure Economic developments in Canada last year 2.5). Overall, real activity in the region remains below mirrored those in the United States, with the pace its potential level and unemployment is still high. There of economic activity moderating in midyear. The is, however, substantial variation across economies. The deceleration reflected not only the drag on Canadian degree of economic slack is larger in the periphery of the exports from weak U.S. activity and strong import euro area than in the core, whereas the largest emerging growth from investment spending amid an appreciat- market economies in the region are already operating at ing currency, but also a cooling of some domestic or above capacity. activity, as housing activity softened from unsustain- The recovery in Europe has been gaining traction, ably high levels, consumer spending temporarily despite renewed financial turbulence in peripheral moderated, and the effect of the fiscal stimulus faded. countries of the euro area during the last quarter Canada’s GDP is projected to expand by 2¾ percent of 2010. Concerns about banking sector losses and this year, with domestic demand in general and fiscal sustainability led to widening sovereign spreads private investment in particular, in line with strong in these countries, in some cases reaching highs not commodity prices, being the primary drivers of seen since the launch of the Economic and Monetary growth; the strong loonie is expected to continue to Union. But the situation was contained by strong be a drag on growth. Risks to the growth outlook policy responses at both the national and the EU are tilted to the downside, with the main domestic level—that is, measures to improve fiscal balances risk being deterioration of housing markets and and push forward with structural reforms in the household balance sheets. Key external risks are affected countries, extraordinary liquidity support, lower-than-expected activity in the United States and securities purchases by the European Central Bank renewed sovereign strains in Europe. (ECB), and funding from the European Financial Canada’s macroeconomic policies rightly remain Stabilization Mechanism (EFSM) and the European accommodative as output remains about 2 percent Financial Stability Facility (EFSF) to support the below potential. Given the downside risks to the joint EU/IMF program for Ireland. Consequently, growth outlook, muted inflation pressures, and the the damage to economic activity was limited to the forthcoming withdrawal of stimulus, a wait-and-see affected economies and did not spread to the rest of attitude seems appropriate regarding further increases Europe, where growth has become more broad-based in the policy rate. On the fiscal front, recent moves and self-sustained (Figure 2.6).64 International Monetary Fund | April 2011

CHAPTER 2 COUNTRY AND REGIONAL PERSPECTIVES Figure 2.5. Europe: Average Projected Real GDP Growth during 2011–12 (Percent) Below 0 Between 0 and 2 Between 2 and 4 Above 4 Source: IMF staff estimates. The outlook is for a continued gradual and uneven are suffering a sharp and protracted contraction inexpansion (Table 2.2). Advanced Europe’s real GDP public and private balance sheets—which is neededis projected to grow at 1¾ percent in 2011 and to resolve fiscal and competitiveness imbalances—2 percent in 2012. Emerging Europe’s growth is and also face more severe structural unemploymentexpected to be 3¾ percent in 2011 and 4 percent problems (Box 2.1).in 2012. Economic prospects across the region are • In advanced economies outside the euro area,likewise divergent, largely reﬂecting diﬀerences in the recovery prospects are similarly differentiated.state of public and private sector balance sheets and For instance, growth in the United Kingdomthe stance of macroeconomic policies. is projected at 1¾ percent in 2011 as necessary• In Germany, growth is expected to moderate front-loaded fiscal consolidation dampens domestic from 3½ percent last year to 2½ percent this year, demand. But in Sweden, real activity is expected mainly due to the withdrawal of fiscal support to expand by 3¾ percent this year amid rapidly and the slowdown in external demand growth. improving financial conditions and nascent signs In France, growth is projected to be modest, at of overheating in the real estate sector. 1½ percent this year, as consumption growth • In emerging Europe, the rapid recovery is projected is subdued by the retrenchment of fiscal stimu- to continue in Turkey, where robust private demand lus and export growth is weakened by slowing and buoyant credit growth are lifting economic external demand. In Italy, the recovery is expected activity above its potential level amid still-accommo- to remain weak, as long-standing competitiveness dative macroeconomic policies. In Poland, growth problems constrain export growth and the planned is expected to remain solid at about 3¾ percent this fiscal consolidation weighs on private demand. year as corporate profitability rises, the absorption Growth is projected to be much lower in the of EU funds continues, and bank lending resumes. periphery of the euro area because these economies The recovery is projected to remain more subdued International Monetary Fund | April 2011 65

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERY Figure 2.6. Europe: A Gradual and Uneven Recovery in some of the economies that experienced unsus- Continues1 tainable domestic booms (Romania). Downside risks to the outlook continue to prevail. The recovery is proceeding at a moderate pace. Real activity in the region remains In the near term, continued strains in more vulner- below its potential level, and inflation pressure is broadly contained. But there are substantial differences across economies. Growth has generally become more able euro area sovereigns and banks pose a significant broad-based and self-sustained in both advanced and emerging Europe. In the euro threat to financial stability and growth, as discussed in area periphery, however, continued financial turbulence is dampening the outlook for these economies. Chapter 1 of the April 2011 Global Financial Stabil- ity Report. This is mainly due to continuing weakness 8 Output Gap Inflation 12 (percent of potential GDP) (percent) among financial institutions in many of the region’s 6 Other 10 advanced economies and a lack of transparency about advanced Emerging 4 Europe Europe Europe 8 their exposures. Financial institutions and sovereigns 2 Euro area are closely linked, with spillovers occurring in both 6 0 directions. Substantial cross-border linkages, as well as Other 4 financial spillovers through higher risk aversion and -2 advanced Europe Europe lower equity prices, could generate a slowdown in -4 Euro area 2 Emerging growth and demand that would hinder the regional Europe -6 0 and global recoveries. Another downside risk to growth 2000 02 04 06 08 10 12 2003 05 07 09 11 12 Contribution to Growth stems from higher-than-expected commodity prices. GDP growth Private consumption Public consumption In the medium term, the main risk remains that Fixed investment Net exports Change in inventories deep-rooted fiscal and competitiveness imbalances in 5 Advanced Europe Emerging Europe 12 4 (percent) (percent) peripheral economies and incomplete action to address 8 banking sector vulnerabilities in many euro area 3 2 4 economies could lead to a long period of slow growth. 1 Comprehensive, rapid, and decisive policy actions 0 0 are required to address these downside risks. Important -1 -2 -4 steps have already been taken at both the national and -3 -8 the EU level. But further bold steps are needed to secure -4 fiscal sustainability, resolve banking sector problems, -5 -12 2007 08 09 10 11 12 13 2007 08 09 10 11 12 13 reform EU policy frameworks, and rekindle growth. Government Bond Spreads2 Money Market Spreads 2,3 Securing public debt sustainability remains a priority (two-year yield spreads 1000 over German bunds, basis 2000 (basis points) Euro 50 ECB deposit 450 for most European economies. Current fiscal consoli- LIBOR–OIS points) facility spread 400 dation plans are broadly appropriate and rightfully Greece 800 (right scale) 1600 45 (billions of (three-month differentiated in the near term. In 2011, the largest euros; forward; left 350 Ireland Portugal 40 right scale) 300 economies in the region (France, Germany, Spain, 600 Spain 1200 scale) 250 United Kingdom) will implement differing measures (in 35 400 800 200 size and composition) to reduce their deficits. Sovereigns 30 150 that have come under market pressure (Greece, Ireland, 200 400 100 Portugal) will continue with sizable front-loaded consol- 25 50 idation. Nonetheless, in many European countries, more 0 0 20 0 Jan. Apr. July Oct. Jan. Mar. Jan. Apr. July Oct. Jan. Mar. needs to be done to underpin medium-term adjustment 10 11 10 11 plans with concrete and sustained policies. In addition, Sources: Bloomberg Financial Markets; and IMF staff estimates. 1Euro Area: Austria, Belgium, Cyprus, Finland, France, Germany, Greece, Ireland, Italy, current plans for medium-term fiscal adjustment still Luxembourg, Malta, Netherlands, Slovak Republic, Slovenia, and Spain. Emerging Europe: need to be strengthened in the face of looming increases Albania, Bosnia and Herzegovina, Bulgaria, Croatia, Hungary, Kosovo, Latvia, Lithuania, Former Yugoslav Republic of Macedonia, Montenegro, Poland, Romania, Serbia, and in pension and health spending.4 Some economies have Turkey. Other advanced Europe comprises Czech Republic, Denmark, Estonia, Iceland, taken steps toward entitlement spending reforms (for Norway, Portugal, Sweden, Switzerland, and United Kingdom. Aggregates are computed on the basis of purchasing-power-parity weights. 2Vertical lines on each panel correspond to May 10 and November 30, 2010. 3ECB: European Central Bank; LIBOR: London interbank offered rate; OIS: overnight 4See Bornhorst and others (2010) for details. index swap.66 International Monetary Fund | April 2011

CHAPTER 2 COUNTRY AND REGIONAL PERSPECTIVESTable 2.2. Selected European Economies: Real GDP, Consumer Prices, Current Account Balance, andUnemployment(Annual percent change unless noted otherwise) Real GDP Consumer Prices1 Current Account Balance2 Unemployment3 Projections Projections Projections Projections 2010 2011 2012 2010 2011 2012 2010 2011 2012 2010 2011 2012Europe 2.1 2.0 2.2 2.4 2.9 2.2 0.3 0.2 0.2 ... ... ... Advanced Europe4 1.7 1.7 1.9 1.9 2.5 1.8 0.8 0.8 0.9 9.3 9.2 8.9 Euro Area5,6,7 1.7 1.6 1.8 1.6 2.3 1.7 –0.6 0.0 0.0 10.0 9.9 9.6 Germany 3.5 2.5 2.1 1.2 2.2 1.5 5.3 5.1 4.6 6.9 6.6 6.5 France 1.5 1.6 1.8 1.7 2.1 1.7 –2.1 –2.8 –2.7 9.7 9.5 9.1 Italy 1.3 1.1 1.3 1.6 2.0 2.1 –3.5 –3.4 –3.0 8.5 8.6 8.3 Spain –0.1 0.8 1.6 2.0 2.6 1.5 –4.5 –4.8 –4.5 20.1 19.4 18.2 Netherlands 1.7 1.5 1.5 0.9 2.3 2.2 7.1 7.9 8.2 4.5 4.4 4.4 Belgium 2.0 1.7 1.9 2.3 2.9 2.3 1.2 1.0 1.2 8.4 8.4 8.2 Austria 2.0 2.4 2.3 1.7 2.5 2.0 3.2 3.1 3.1 4.4 4.3 4.3 Greece –4.5 –3.0 1.1 4.7 2.5 0.5 –10.4 –8.2 –7.1 12.5 14.8 15.0 Portugal 1.4 –1.5 –0.5 1.4 2.4 1.4 –9.9 –8.7 –8.5 11.0 11.9 12.4 Finland 3.1 3.1 2.5 1.7 3.0 2.1 3.1 2.8 2.6 8.4 8.0 7.8 Ireland –1.0 0.5 1.9 –1.6 0.5 0.5 –0.7 0.2 0.6 13.6 14.5 13.3 Slovak Republic 4.0 3.8 4.2 0.7 3.4 2.7 –3.4 –2.8 –2.7 14.4 13.3 12.1 Slovenia 1.2 2.0 2.4 1.8 2.2 3.1 –1.2 –2.0 –2.1 7.2 7.5 7.2 Luxembourg 3.4 3.0 3.1 2.3 3.5 1.7 7.7 8.5 8.7 6.1 5.9 5.8 Estonia 3.1 3.3 3.7 2.9 4.7 2.1 3.6 3.3 3.1 16.9 14.8 12.8 Cyprus 1.0 1.7 2.2 2.6 3.9 2.8 –7.0 –8.9 –8.7 6.8 6.5 6.3 Malta 3.6 2.5 2.2 2.0 3.0 2.6 –0.6 –1.1 –2.3 6.5 6.5 6.4 United Kingdom6 1.3 1.7 2.3 3.3 4.2 2.0 –2.5 –2.4 –1.9 7.8 7.8 7.7 Sweden 5.5 3.8 3.5 1.9 2.0 2.0 6.5 6.1 5.8 8.4 7.4 6.6 Switzerland 2.6 2.4 1.8 0.7 0.9 1.0 14.2 13.2 12.8 3.6 3.4 3.3 Czech Republic 2.3 1.7 2.9 1.5 2.0 2.0 –2.4 –1.8 –1.2 7.3 7.1 6.9 Norway 0.4 2.9 2.5 2.4 1.8 2.2 12.9 16.3 16.0 3.6 3.6 3.5 Denmark 2.1 2.0 2.0 2.3 2.0 2.0 5.0 4.8 4.8 4.2 4.5 4.4 Iceland –3.5 2.3 2.9 5.4 2.6 2.6 –8.0 1.1 2.1 8.1 7.5 6.5 Emerging Europe8 4.2 3.7 4.0 5.3 5.1 4.2 –4.3 –5.4 –5.7 ... ... ... Turkey 8.2 4.6 4.5 8.6 5.7 6.0 –6.5 –8.0 –8.2 11.9 11.4 11.0 Poland 3.8 3.8 3.6 2.6 4.1 2.9 –3.3 –3.9 –4.2 9.0 9.0 8.7 Romania –1.3 1.5 4.4 6.1 6.1 3.4 –4.2 –5.0 –5.2 7.6 6.6 5.8 Hungary 1.2 2.8 2.8 4.9 4.1 3.5 1.6 1.5 0.9 11.2 11.5 10.9 Bulgaria 0.2 3.0 3.5 3.0 4.8 3.7 –0.8 –1.5 –2.0 10.3 8.0 6.7 Serbia 1.8 3.0 5.0 6.2 9.9 4.1 –7.1 –7.4 –6.6 19.4 19.6 19.8 Croatia –1.4 1.3 1.8 1.0 3.5 2.4 –1.9 –3.6 –3.6 12.3 12.8 12.3 Lithuania 1.3 4.6 3.8 1.2 3.1 2.9 1.8 –0.9 –2.9 17.8 16.0 14.0 Latvia –0.3 3.3 4.0 –1.2 3.0 1.7 3.6 2.6 1.5 19.0 17.2 15.5 1Movements in consumer prices are shown as annual averages. December–December changes can be found in Tables A6 and A7 in the Statistical Appendix. 2Percent of GDP. 3Percent. National deﬁnitions of unemployment may differ. 4Includes Estonia. 5Current account position corrected for reporting discrepancies in intra-area transactions. 6Based on Eurostat’s harmonized index of consumer prices. 7Excludes Estonia. 8Includes Albania, Bosnia and Herzegovina, Kosovo, former Yugoslav Republic of Macedonia, Montenegro, and Serbia.example, France, Greece, Ireland, Italy, Spain), but more Specifically, in the euro area, asset quality is uncertain,should be done in this area. and banks face a wall of maturing debt and therefore Remaining fragilities in Europe’s financial remain vulnerable to funding pressures in wholesalesystem urgently need to be resolved. As discussed in markets. The desire to reduce the dependence onChapter 1 of the April 2011 Global Financial Stabil- wholesale funding has sparked a deposit war in severality Report, progress in strengthening capital positions economies, squeezing bank revenues. Overall, someand reducing leverage has been uneven in Europe. euro area banks face significant capital shortfalls. To International Monetary Fund | April 2011 67

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERY help address such weaknesses, it is critical to reduce The immediate priority is to reassure markets that uncertainty about asset quality, increase the capital sufficient resources are available from the euro-wide buffers of viable banks, and identify and resolve weak safety net to deal with downside risks. European leaders banks. In this respect, some economies (for example, committed at the March EU summit to substantially Spain) have made more progress than others. New increase the effective lending capacity of the EFSF. stress tests that are more realistic, thorough, and trans- While this should bolster market confidence, the mecha- parent will increase clarity. But they will be effective nism by which this is secured should be clarified as only if embedded in coordinated national strategies soon as possible, and a decision on adjusting the interest to deal with vulnerable institutions—an approach rate charged on EFSF loans is urgently needed to help policymakers committed to at the March EU summit. support fiscal sustainability. Beyond 2013, the proposed Meanwhile, excess capacity in banking systems needs permanent European Stability Mechanism provides a to be removed by resolving the weak tail of banks. robust and orderly framework to assist euro area mem- Without these reforms, financial systems in Europe bers, with strict conditionality to support discipline. will remain vulnerable, credit growth could come Some additional flexibility on these instruments would under further pressure, and the economic recovery be helpful to deal more directly with the interdepen- could be undermined. dence of national banking systems and sovereign risks. In most European economies, monetary policy can Beyond crisis-management measures, the crisis has stay accommodative for as long as inflation pressures highlighted the need to improve EU policy coordina- remain subdued. In advanced Europe, core inflation is tion on fiscal and structural issues. Shared responsi- projected to remain low because inflation expectations bility for fiscal burdens needs to come with shared are well anchored and excess capacity is still large in responsibility for fiscal policies. To this end, policy- most economies. Also, the impact of recent increases makers agreed in March to strengthen fiscal frame- in commodity prices should prove temporary. This works, through a stronger Stability and Growth Pact, argues for low policy rates for now to support the minimum standards to be set for national frame- recovery and help offset the dampening short-term works, and enhanced coordination with the Euro- effects of fiscal consolidation on domestic demand. pean Semester. Improved surveillance over structural Still, central banks will have to keep a watchful eye bottlenecks, competitiveness, and imbalances is also on wage developments and inflation expectations for needed to help address macroeconomic imbalances. potential second-round effects, especially in countries In that respect, the recently agreed Euro Plus Pact that are most advanced in their recoveries. In the euro and the forthcoming Excessive Imbalances Procedure area, remaining financial fragilities could hold back are welcome coordination tools, but specific reforms growth, justifying a slower pace of normalization. will need to be identified and implemented without Moreover, the ECB’s extraordinary measures will need further delay. Furthermore, the surveillance process to be removed only gradually as systemic uncertainty should be made more binding by introducing sanc- recedes. In emerging Europe, inflation prospects are tions and ensuring that the delay between diagnosis more mixed, which reflects mainly different degrees of and policy action is kept short. economic slack and variable pass-through of commod- Another lesson from the crisis is the need for an ity prices into overall inflation. In some fast-growing integrated, pan-European approach to supervision, emerging economies, policy rates may need to be regulation, and crisis management and resolution. normalized sooner to prevent overheating. Financial sector problems in specific countries can A key challenge ahead is to reform euro area and spread quickly across the region, and supervisory and EU policy frameworks to help restore confidence and regulatory gaps can have major spillovers. Hence, secure Europe’s future stability and growth. The crisis more joint responsibility and accountability for revealed deep-rooted problems, with significant cross- Europe’s financial stability are urgently needed. This border dimensions, in existing fiscal, structural, and can be achieved through integrated crisis manage- financial stability policies. To address these problems, ment and resolution as well as integrated supervi- comprehensive solutions are needed. sion, which should help establish some consensus on68 International Monetary Fund | April 2011

CHAPTER 2 COUNTRY AND REGIONAL PERSPECTIVESburden sharing. Some steps in this direction are being risk sharing via a truly integrated and better super-taken with the creation of the European Systemic vised and regulated financial market.Risk Board and the establishment of the EuropeanSupervisory Authorities. But the success of these newinstitutions will depend on adequate resources, good A Moderate Recovery Continues in theinformation gathering and sharing, and focused coor- Commonwealth of Independent Statesdination of their activities. More important, overall The recovery in the CIS is proceeding at a steadyprogress toward an integrated European financial pace (Figure 2.7). Having suffered a collapse during thestability framework has been disappointingly slow, crisis, real activity in the region remains substantiallyespecially considering its importance for achieving an below its potential level, despite notable differences acrossefficient and stable market for financial services that economies.spreads risks among countries and fosters economic Several factors are supporting the recovery. Highergrowth in Europe. commodity prices are boosting production and In many ways, the European Union and the euro employment in the region’s commodity-exportingarea are at a crossroads. Popular support for the euro economies. Also, the rebound in real activity inremains strong, considering the tensions created by Russia is benefiting other CIS economies throughsharing sovereign risk. But unless economies make trade, remittances, and investment. In addition,a quantum leap toward a more integrated approach there continues to be a gradual normalization ofto fiscal policy and assume joint responsibility for trade and capital flows to the region. Nevertheless,financial stability, support for burden sharing may be heavy dependence on external financing and linger-much lower in future crises. If taken, however, these ing banking sector vulnerabilities are holding backsteps can deliver the major benefits that derive from growth in several CIS economies. Figure 2.7. Commonwealth of Independent States: Average Projected Real GDP Growth during 2011–12 (Percent) Below 0 Between 0 and 2 Between 2 and 4 Above 4 Insufficient data Covered in a different map Source: IMF staff estimates. Note: Includes Georgia and Mongolia. International Monetary Fund | April 2011 69

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERY Figure 2.8. Commonwealth of Independent States: Against this backdrop, real activity in the CIS is A Moderate Recovery is under Way projected to expand by 5 percent in 2011 and 4¾ percent in 2012, coming closer to its potential level only gradually. Within the region, however, growth The recovery is continuing at a steady pace. Having suffered a collapse during the prospects differ substantially (Figure 2.8; Table 2.3): crisis, real activity in the CIS region remains substantially below its potential level, despite notable differences across economies. Inflation is on the rise, led by higher • In Russia, growth is projected to pick up modestly prices for food, which makes up a large share of the consumption basket in the to 4¾ percent in 2011 and 4½ percent in 2012, region. only gradually reducing the output gap. Private 8 Output Gap Inflation 25 sector demand is likely to remain subdued as non- (percent of potential GDP) (percent) 6 performing loans in the banking system constrain Net energy 4 CIS importers1 Net energy 20 credit and consumption growth. importers1 2 • Among other energy exporters, economies whose CIS 0 15 financial sectors have fewer external linkages are Russia -2 Russia expected to continue to perform best. In particu- -4 10 lar, Turkmenistan is expected to benefit from high -6 Net energy exporters1 gas prices and be among the top performers in the excl. Russia Net energy exporters1 excl. Russia -8 5 region, growing by 9 percent in 2011. In Uzbeki- 2000 02 04 06 08 10 12 2003 05 07 09 11 12 stan, growth is also projected to remain high, at 500 Commodity Prices 2010 CPI Weights for Food2 60 7 percent in 2011, supported by strong domes- (Jan. 2003 = 100) (percent) tic demand, public investment, and commodity 400 50 Oil exports (including gold and cotton). 40 300 • For energy importers as a group, growth is pro- Metals 30 jected at 5¼ percent in 2011 and 5 percent in 200 20 2012 as some of these economies (for example, 100 Food Armenia, Moldova) benefit from the rebound 10 Overall in remittances from Russia and others from the 0 0 an 2003 05 Moldova Armenia 07 09 11 12 return of financial stability (for example, Ukraine). Belarus Georgia Russia Ukraine Kazakhst Despite the considerable degree of economic slack, inflation is on the rise across the region, led by higher food prices. Unfavorable weather conditions 20 Current Account Balance Net Financial Flows 15 (percent of GDP) (percent of GDP) in 2010 reduced grain yields and contributed to price 15 Total Flows 10 spikes. Food comprises a large share of the region’s CIS 5 consumer price inflation basket (30 to 50 percent; 10 0 see Figure 2.8), and so rising food prices are expected 5 -5 to substantially increase headline inflation. Given the 0 limited credibility of monetary policy frameworks in Net energy -10 Direct investment the region, this will likely feed into more generalized importers1 Private portfolio flows -5 -15 Net energy Other private flows wage and core inflation pressures. exporters1 Official flows -10 2000 02 04 06 08 10 12 1992 96 2000 04 08 12 16 -20 Risks to the outlook in the region are broadly balanced. For most CIS economies, growth prospects Sources: Haver Analytics; IMF, Primary Commodity Price System; and IMF staff remain highly dependent on the speed of recovery estimates. 1 Net energy exporters: Azerbaijan, Kazakhstan, Russia, Turkmenistan, and Uzbekistan. in Russia, which could surprise in either direction. Net energy importers: Armenia, Belarus, Georgia, Kyrgyz Republic, Moldova, Mongolia, Higher commodity prices represent an upside risk Tajikistan, and Ukraine. Aggregates for the external economy are sums of individual country data. Aggregates for all others are computed on the basis of purchasing-power-parity to growth in commodity-exporting economies in weights. the region; increased global risk aversion or lower 2 Data for Belarus are for 2008; CPI = consumer price index. external demand from advanced economies present downside risks to growth.70 International Monetary Fund | April 2011

CHAPTER 2 COUNTRY AND REGIONAL PERSPECTIVESTable 2.3. Commonwealth of Independent States: Real GDP, Consumer Prices, Current AccountBalance, and Unemployment(Annual percent change unless noted otherwise) Real GDP Consumer Prices1 Current Account Balance2 Unemployment3 Projections Projections Projections Projections 2010 2011 2012 2010 2011 2012 2010 2011 2012 2010 2011 2012Commonwealth of Independent States (CIS)4 4.6 5.0 4.7 7.2 9.6 8.1 3.8 4.7 3.2 ... ... ...Russia 4.0 4.8 4.5 6.9 9.3 8.0 4.9 5.6 3.9 7.5 7.3 7.1Ukraine 4.2 4.5 4.9 9.4 9.2 8.3 –1.9 –3.6 –3.8 8.1 7.8 7.2Kazakhstan 7.0 5.9 5.6 7.4 9.1 6.4 2.5 5.8 4.2 5.8 5.7 5.6Belarus 7.6 6.8 4.8 7.7 12.9 9.7 –15.5 –15.7 –15.2 0.7 0.7 0.7Azerbaijan 5.0 2.8 2.5 5.7 10.3 7.5 27.7 28.4 24.2 6.0 6.0 6.0Turkmenistan 9.2 9.0 6.4 4.4 6.1 7.3 –11.4 –4.7 –3.9 ... ... ...Mongolia 6.1 9.8 7.1 10.2 16.4 16.0 –15.2 –13.3 –14.0 3.3 3.0 3.0 Low-Income CIS 6.0 5.0 4.8 7.4 11.4 9.2 11.0 13.1 10.3 ... ... ... Uzbekistan 8.5 7.0 7.0 9.4 11.6 12.3 6.7 10.0 6.7 0.2 0.2 0.2 Georgia 6.4 5.5 4.8 7.1 12.6 7.9 –9.8 –13.0 –12.0 16.8 16.7 16.5 Armenia 2.6 4.6 4.3 8.2 9.3 5.5 –13.7 –12.4 –11.3 7.0 7.0 7.0 Tajikistan 6.5 5.8 5.0 6.5 13.9 9.7 2.2 –4.1 –7.2 ... ... ... Kyrgyz Republic –1.4 5.0 6.0 7.8 18.8 9.3 –7.4 –6.7 –7.8 5.8 5.6 5.5 Moldova 6.9 4.5 4.8 7.4 7.5 6.3 –10.9 –11.1 –11.2 7.4 6.5 6.0MemorandumNet Energy Exporters5 4.4 5.0 4.6 6.9 9.4 8.0 5.3 6.3 4.5 ... ... ...Net Energy Importers6 5.1 5.3 4.9 8.7 10.7 8.7 –6.5 –7.9 –8.0 ... ... ... 1Movements in consumer prices are shown as annual averages. December–December changes can be found in Table A7 in the Statistical Appendix. 2Percent of GDP. 3Percent. National deﬁnitions of unemployment may differ. 4Georgia and Mongolia, which are not members of the Commonwealth of Independent States, are included in this group for reasons of geography and similarities ineconomic structure. 5Net Energy Exporters comprise Azerbaijan, Kazakhstan, Russia, Turkmenistan, and Uzbekistan. 6Net Energy Importers comprise Armenia, Belarus, Georgia, Kyrgyz Republic, Moldova, Mongolia, Tajikistan, and Ukraine. The key policy challenge in the region is to exit from it reduces the scope for conflict between the exchangecrisis-related macroeconomic and financial policies in a rate and inflation and deters speculative capital flows.way that provides sufficient support to the incomplete Given steady increases in nonfood prices and unfa-recovery but does not jeopardize price stability. vorable inflation prospects, an increase in policy inter-• On the financial front, the main policy task is to est rates would help prevent a wage-price spiral. address lingering vulnerabilities. The consider- • On the fiscal front, the specific policy challenges able banking risks in Russia, for instance, call vary across the region. In Russia, following the large for strengthening capital adequacy requirements, fiscal stimulus (about 9 percent of GDP) imple- enhancing supervisory powers, and implement- mented during the crisis, the main task is to deliver ing legislation on consolidated supervision and a more ambitious, credible, and growth-friendly connected lending. In several economies (Kazakh- plan for medium-term consolidation. In Kazakh- stan, Kyrgyz Republic, Tajikistan), the top priority stan, where fiscal policy continues to support the is comprehensive and transparent strategies to recovery, the efficiency of public spending should be address nonperforming loans in the banking sector. ensured. In a number of economies (for example,• Because most economies in the region operate under Armenia, Georgia, Kyrgyz Republic) where the pegged or heavily managed exchange rate regimes, share of food in the consumption basket is high, there is only limited scope for monetary policy to poor households will bear the brunt of any price respond to shocks. In this context, the increased increases. Hence, there is a need to better target exchange rate flexibility in Russia is welcome because government support for low-income households. International Monetary Fund | April 2011 71

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERY Rapid Growth Continues in Asia authorities to tighten the policy stance more rapidly than previously planned may have contributed to recent Broad-based recovery is continuing in most Asian declines in equity and bond markets. economies, supported by strong export performance, Against this backdrop, Asia is projected to continue buoyant private domestic demand, and in some cases expanding rapidly this year and next. Export growth rapid credit growth. Even though growth has moder- is expected to moderate from last year’s very rapid ated from cyclical highs to more sustainable rates, Asia pace but will remain robust as gains in market share continues to outpace other regions (Figure 2.9; Table and increased intraregional trade partially offset the 2.4). With the notable exception of Japan, output gaps weakness in final demand from advanced economies. in much of the region have closed or are quickly closing, Capital flows to Asia are likely to continue, driven inflation is on the rise, and overheating is becoming a by both cyclical and structural factors. Autonomous concern. At the same time, limited progress has been private consumption growth should remain strong, made on external rebalancing in emerging Asia. supported by still-rich asset valuations and improved Signs of overheating are starting to materialize in labor market conditions. a number of economies. Continued high growth has • After growing by 10¼ percent in 2010, China’s meant that some economies in the region are now oper- growth is expected to remain robust at 9½ percent ating at or above potential (Figure 2.10). Credit growth this year and next, with the drivers of growth shift- is accelerating in some economies (Hong Kong SAR, ing increasingly from public to private demand. India, Indonesia), and it remains high in China. Most Consumption will be buttressed by rapid credit of the increase in headline inflation in recent months growth, supportive labor market conditions, and has been due to a spike in food prices, but core inflation continued policy efforts to raise household dispos- has also been increasing in a number of economies, able income. most notably India. Furthermore, real estate prices have • Growth in India is expected to moderate but been rising at double-digit rates in a number of econo- remain above trend, with GDP growth projected mies. Concerns that inflation pressures may induce at 8¼ percent in 2011 and 7¾ percent in 2012. Figure 2.9. Asia: Average Projected Real GDP Growth during 2011–12 (Percent) Below 0 Between 0 and 2 Between 2 and 4 Above 4 Insufficient data Source: IMF staff estimates.72 International Monetary Fund | April 2011

CHAPTER 2 COUNTRY AND REGIONAL PERSPECTIVESTable 2.4. Selected Asian Economies: Real GDP, Consumer Prices, Current Account Balance, and Unemployment(Annual percent change unless noted otherwise) Real GDP Consumer Prices1 Current Account Balance2 Unemployment3 Projections Projections Projections Projections 2010 2011 2012 2010 2011 2012 2010 2011 2012 2010 2011 2012Asia 8.2 6.7 6.8 4.3 4.7 3.4 3.3 3.1 3.1 ... ... ... Advanced Asia 5.3 2.8 3.1 0.8 1.8 1.5 3.4 2.8 2.4 4.8 4.5 4.3 Japan 3.9 1.4 2.1 –0.7 0.2 0.2 3.6 2.3 2.3 5.1 4.9 4.7 Australia 2.7 3.0 3.5 2.8 3.0 3.0 –2.6 –0.4 –2.1 5.2 5.0 4.8 New Zealand 1.5 0.9 4.1 2.3 4.1 2.7 –2.2 –0.2 –4.4 6.5 6.7 6.2 Newly Industrialized Asian Economies 8.4 4.9 4.5 2.3 3.8 2.9 7.1 6.3 6.0 4.1 3.6 3.6 Korea 6.1 4.5 4.2 3.0 4.5 3.0 2.8 1.1 1.0 3.7 3.3 3.3 Taiwan Province of China 10.8 5.4 5.2 1.0 2.0 2.0 9.4 11.6 10.9 5.2 4.6 4.5 Hong Kong SAR 6.8 5.4 4.2 2.4 5.8 4.4 6.6 5.2 5.5 4.3 3.6 3.8 Singapore 14.5 5.2 4.4 2.8 3.3 3.0 22.2 20.4 19.0 2.2 2.2 2.2 Developing Asia 9.5 8.4 8.4 6.0 6.0 4.2 3.3 3.3 3.6 ... ... ... China 10.3 9.6 9.5 3.3 5.0 2.5 5.2 5.7 6.3 4.1 4.0 4.0 India 10.4 8.2 7.8 13.2 7.5 6.9 –3.2 –3.7 –3.8 ... ... ... ASEAN-5 6.9 5.4 5.7 4.4 6.1 4.7 3.5 2.7 2.2 ... ... ... Indonesia 6.1 6.2 6.5 5.1 7.1 5.9 0.9 0.9 0.4 7.1 6.7 6.5 Thailand 7.8 4.0 4.5 3.3 4.0 3.4 4.6 2.7 1.9 1.0 1.2 1.2 Malaysia 7.2 5.5 5.2 1.7 2.8 2.5 11.8 11.4 10.8 3.3 3.2 3.1 Philippines 7.3 5.0 5.0 3.8 4.9 4.3 4.5 2.9 2.8 7.2 7.2 7.2 Vietnam 6.8 6.3 6.8 9.2 13.5 6.7 –3.8 –4.0 –3.9 5.0 5.0 5.0 Other Developing Asia4 5.7 4.7 5.2 9.1 10.9 9.6 –0.6 –1.3 –1.8 ... ... ...MemorandumEmerging Asia5 9.4 7.9 7.9 5.5 5.7 4.0 3.9 3.8 4.0 ... ... ... 1Movements in consumer prices are shown as annual averages. December–December changes can be found in Tables A6 and A7 in the Statistical Appendix. 2Percentof GDP. 3Percent. National deﬁnitions of unemployment may differ. 4Other Developing Asia comprises Islamic Republic of Afghanistan, Bangladesh, Bhutan, Brunei Darussalam, Cambodia, Republic of Fiji, Kiribati, Lao People’s Democratic Republic,Maldives, Myanmar, Nepal, Pakistan, Papua New Guinea, Samoa, Solomon Islands, Sri Lanka, Timor-Leste, Tonga, Tuvalu, and Vanuatu. 5Emerging Asia comprises all economies in Developing Asia and the Newly Industrialized Asian Economies. Infrastructure will remain a key contributor to strong consumption and a recovery in investment growth, and corporate investment is expected to will raise growth to 6¼ percent this year and 6½ accelerate as capacity constraints start to bind and percent in 2012. funding conditions remain supportive. • Japan’s growth of 4 percent in 2010 was one• After very rapid growth last year, growth in the of the fastest among the advanced economies, newly industrialized Asian economies (NIEs) is driven by sizable fiscal stimulus and a rebound expected to moderate to a more sustainable 5 in exports. Looking forward, however, there are percent in 2011, roughly in line with potential. large uncertainties associated with the Tohuku Although the deceleration reflects the end of the earthquake. Official estimates of the damage to inventory cycle, exports and private consumption the capital stock are about 3 to 5 percent of GDP, will remain important drivers of growth. roughly twice that of the 1995 Kobe earthquake.• The ASEAN-5 economies5 are projected to expand This figure, however, does not account for the by 5½ percent in 2011 and 5¾ percent in 2012. effects of possible power shortages and ongoing The ASEAN-5 will be led by Indonesia, where risks associated with the crisis at the Fukushima Daiichi nuclear power plant. Assuming that the 5The Association of Southeast Asian Nations (ASEAN) includes power shortages and the nuclear crisis are resolvedIndonesia, Malaysia, Philippines, Thailand, and Vietnam. within a few months, growth is projected to slow International Monetary Fund | April 2011 73

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERY 1 to 1½ percent in 2011 before recovering to 2Figure 2.10. Asia: Still in the Lead percent in 2012.6 • In Australia, flooding in key mining and agricul-Asia continues to outpace other regions, buoyed by resilient exports and strongdomestic demand. In some emerging Asian economies, output gaps have closed, tural regions is expected to subtract from growthcore inflation is on the rise, and credit growth is rapid. Persistently large current in early 2011, but over the year this will be offsetaccount surpluses still dominate capital inflows, but many countries continue toresist currency appreciation. by stronger private investment in mining and stronger commodity exports; GDP is projected Asia: Contribution to Growth2 Output Gap to grow by 3 percent this year and 3½ percent in10 (percent change) (percent of potential GDP) 4 2012. Recent earthquakes will slow activity in New 8 2 Zealand this year, with real GDP growth projected 6 Emerging Asia 4 0 at 1 percent, but growth is expected to rise to 4 2 Asia percent in 2012, led by reconstruction. -2 0 With continued rapid growth, output now close GDP growth to potential levels, and monetary conditions remain--2 Private consumption -4-4 Public consumption ing accommodative, inflation is expected to continue Investment -6-6 Net exports Advanced Asia increasing this year across much of developing Asia. Discrepancy-8 2004 06 08 10 12 2004 06 08 10 12 -8 Inflation pressure is most evident in India, where despite some moderation, inflation has become more14 Core Inflation Credit Growth (annualized 70 generalized and is projected to remain high—averag- (year-over-year percent change) percent change of three-month12 moving average over previous 60 ing 7½ percent this year. In other parts of developing India3 three-month moving average)10 NIEs 50 Asia, inflation is lower but is on the rise. In China, 8 China ASEAN-5 ASEAN-5 40 price pressures that started in a narrow range of food India 6 products have broadened into other items, including 30 4 20 housing, and inflation is projected to reach 5 percent 2 10 this year. Similar patterns of accelerating and more 0 China 0 generalized inflation are becoming evident in the -2 Advanced Asia Advanced Asia NIEs -10 region’s other developing economies—for developing -4 2004 06 08 Feb. 2006 07 08 09 Jan. Asia as a whole, inflation is projected at 6 percent 11 11 this year. In stark contrast, mild deflation continues6 Current Account Balance Emerging Asia: Sources of 15 (percent of Asia’s total GDP) Reserve Accumulation (percent of in Japan, and inflation expectations there have not Asia GDP; from 2009:Q4 to 2010:Q4)5 10 improved substantially. Advanced Asia and NIEs Risks to the growth outlook come from both4 Developing Asia 5 outside and inside the region. Despite a substantial3 0 increase in intraregional trade, two-thirds of the final2 Reserve accumulation -5 demand for Asian exports still comes from outside Current account the region, and renewed turbulence in the euro area1 Financial account -10 Capital account and would affect Asia primarily through trade linkages. errors and omissions0 -15 An additional external risk is stronger-than-expected 2004 06 08 10 12 14 16 NIEs ASEAN-44 India China increases in oil and commodity prices. Turning to Sources: CEIC Asia database; Haver Analytics; and IMF staff estimates. risks from within Asia, if accommodative policies fail 1Advanced Asia: Australia, Japan, and New Zealand; newly industrialized Asian to adjust sufficiently to nascent overheating pressures,economies (NIEs): Hong Kong SAR, Korea, Singapore, and Taiwan Province of China;developing Asia: rest of Asia; ASEAN-5: Indonesia, Malaysia, Philippines, Thailand, and near-term growth may surprise on the upside. ButVietnam; emerging Asia: developing Asia and NIEs. Aggregates for the external economyare sums of individual country data. Aggregates for all others are computed on the basis of that could sow the seeds for a hard landing down thepurchasing-power-parity weights. 2Excludes Bhutan, Brunei Darussalam, Fiji, Kiribati, Lao People’s Democratic Republic, road. In particular, an abrupt slowdown of economicSamoa, Timor-Leste, Tonga, Tuvalu, and Vanuatu due to data limitations. 3Wholesale price index excluding food and energy. 4ASEAN-4: ASEAN-5 excluding Vietnam. 6 The April 2011 Global Financial Stability Report discusses the financial stability implications of the recent events in Japan.74 International Monetary Fund | April 2011

CHAPTER 2 COUNTRY AND REGIONAL PERSPECTIVESactivity in China, perhaps following a credit and is slow, given how rapidly the region has been grow-property boom-bust cycle, would adversely affect the ing. A more rapid exit would allow governments towhole region. Such boom-bust dynamics are also a build the fiscal room they need to cope with adversepossibility in other emerging Asian economies, such shocks in the future. Countercyclical fiscal policyas some of the NIEs (Hong Kong SAR, Singapore). would also help cushion domestic demand against Although Asia’s external surplus has narrowed sub- the effect of capital inflows. In Japan, the recentstantially—from a peak of 5¼ percent of regional GDP downgrade of sovereign debt has highlighted thein 2007 to about 3¼ percent of GDP in 2010—that importance of having a more credible fiscal adjust-narrowing is not expected to continue. As external ment plan. Once the extent of the earthquake’s dam-demand recovers and fiscal stimulus is withdrawn, the age becomes clearer and reconstruction efforts areregion’s external surpluses are projected to widen again under way, the authorities will need a more crediblein the coming years, with developing Asia in general fiscal strategy that brings down the public debt ratioand China in particular accounting for the bulk of over the medium term while addressing the need forthe surplus, especially in the medium term (see Figure additional reconstruction spending.2.10). In fact, there has been little progress toward Managing capital inflows is another major policyrebalancing; the projected surpluses for the region are challenge for Asia. For economies in the region thatnow larger than they were in the October 2010 World continue to run large current account surpluses butEconomic Outlook, in both the near and medium term. whose response to capital inflows has been contin-Developing Asia’s current account balances are sub- ued reserve accumulation, the policy prescription isstantially higher than fundamentals suggest, given the clear—greater exchange rate flexibility. Appreciationregion’s relatively low per capita income, higher expected would not only help address challenges in liquiditygrowth rates, and relatively young population. management, but could reduce expectations of a The primary challenge for Asian policymakers large step appreciation, lessening speculative inflows.is to quickly normalize the stance of fiscal and mon- A stronger prudential framework would also helpetary policies in the region and ensure that boom-like reduce the vulnerabilities that can arise from sizabledynamics do not get out of hand. Monetary policy and potentially volatile capital inflows.remains generally accommodative even as many Although renewed capital inflows have garnered theeconomies have taken steps toward normalization. lion’s share of attention in recent months, these flowsThe further tightening currently expected by markets are still dwarfed by the large current account surplusesin some economies is not enough to prevent inflation in the region. In this area, too, the aforementionedfrom increasing. In addition to more rapid tightening need for greater exchange rate flexibility is critical.of policy rates, greater exchange rate flexibility will be Appreciation would help stimulate domestic demandan important component of policy tightening. The pri- and help shift resources from the tradables to the non-mary response to the resurgence of foreign inflows to tradables sector, facilitating much-needed developmentAsia has been the continued accumulation of reserves. of the services sector in some of the region’s econo-Allowing the exchange rate to appreciate in response to mies. But exchange rate policy must be complementedinflows would be more conducive to normalizing the by structural reforms. Economies where private invest-policy stance. In addition, strengthened supervision ment lags, such as among the ASEAN-5, will benefitand prudential measures are needed to address con- from efforts to boost infrastructure and improve thecerns about deteriorating credit quality, which often business environment. And continued reforms to raiseaccompanies credit and asset price booms. In China, consumption in economies such as China—includingfor instance, there is rising concern that management efforts to expand pension and health care coverage andof credit aggregates, used to exercise macroeconomic to develop the financial sector—will also be key ingre-control, is being undermined by banks’ financial inno- dients of a comprehensive rebalancing package.7vation and off-balance-sheet activities. Fiscal policy is projected to be less supportive ofgrowth this year than last, but the pace of withdrawal 7See, for example, Baldacci and others (2010). International Monetary Fund | April 2011 75

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERY Figure 2.11. Latin America and the Caribbean: Average Projected Real GDP Growth during 2011–12 (Percent) Below 0 Between 0 and 2 Between 2 and 4 Above 4 Insufficient data Source: IMF staff estimates. Latin America Faces Buoyant External Real activity expanded by about 6 percent last Conditions year, after contracting by 1¾ percent in 2009. Robust demand from China and rising commod- The LAC region has weathered the global recession well ity prices continue to underpin this strength (Figure and must now contend with the policy challenges of man- 2.12). More recently, exports to other destinations aging two strong tailwinds—high commodity prices and have also bounced back. This has encouraged strong strong capital inflows. In a number of the larger countries, capital inflows and moderate current account deficits. the baseline forecast is for moderation of the rapid rates of Despite the support to current accounts from com- growth experienced in 2010 and a level of output more modity prices, however, deficits are widening and are in line with potential, but overheating is a significant risk projected to continue widening on the back of robust (Figure 2.11). In other, slower-growing countries that did domestic demand. The generally buoyant conditions not emerge as rapidly from the global recession, there are are associated with rising inflation in South and signs that output is moving closer to potential. Central America. On the other hand, Mexico is not76 International Monetary Fund | April 2011

CHAPTER 2 COUNTRY AND REGIONAL PERSPECTIVESfacing overheating pressure at this time (see Figure Figure 2.12. Latin America and the Caribbean:1.15). Icarus or Daedalus?1 Growth in the region is projected to average 4¾percent in 2011 and 4¼ percent in 2012 (Table 2.5). The prospects for Latin America continue to improve, buoyed by China’s demand for commodities and strong capital flows. These two forces, however, need to beThe growth rate for 2011 is ⅔ percentage point higher carefully managed, lest they lead to overheating.than forecast in the October 2010 World EconomicOutlook (see Figure 2.12). The main reason for this 10 Output Gap Real Export Growth of FICE by 80 (percent of potential GDP) Destination (year-over-yearrevision is greater conﬁdence in the strength of the percent change) 60 5global recovery and improved prospects for commodity Caribbean China 40prices. As with any region, however, experiences vary. 0 20• The outlook for commodity exporters is generally FICE -5 0 positive. In the group of financially integrated com- U.S. and euro area modity exporters (FICE—Brazil, Chile, Colombia, -20 Emerging Asia -10 excl. China2 Peru, Uruguay), growth is projected at 4¾ percent Other LA -40 LAC this year. There are signs, however, of potential -15 -60 2000 02 04 06 08 10 12 2005 07 09 10: overheating, and capital inflows have caused policy Q3 tension. For example, real credit growth in Brazil Total Net Flows Current Account Balance 6 (percent of GDP) (percent of GDP) 15 and Colombia is increasing by 10 to 20 percent a year according to the the most recent data (see Fig- 4 10 ure 2.12). Furthermore, per capita credit in Brazil 2 5 roughly doubled over the past five years.• Prospects for Mexico continue to be closely tied 0 0 to those for the United States. In line with the -2 LAC -5 modest improvement in the outlook for the U.S. FICE Latin America FICE Mexico -4 -10 economy, real activity in 2011 is now projected to Mexico 3 Caribbean Other LA Other LA3 expand by 4½ percent, about ¾ percentage point -6 -15 2000 02 04 06 08 10: 2000 02 04 06 08 10 12 more than in the October forecast. Q3• In Central America, and Panama in particular, the 1.4 Revisions to 2011 Growth Real Credit Growth 50 recovery is strengthening on the back of external (percentage point (year-over-year percent change) 1.2 difference demand, and output gaps are almost closed. Sup- from October 2010 Brazil 40 1.0 forecast) port has also come from a recovery in remittance 30 0.8 flows. These trends are expected to continue. Peru 0.6 20• The outlook for the Caribbean countries has improved in line with the global recovery. Growth 0.4 10 in 2011 is now forecast to be 4¼ percent. Much 0.2 Colombia 0 of this, however, reflects the strong performance 0.0 of the Dominican Republic and post-earthquake -0.2 -10 Average FICE Other LA 3 2006 07 08 09 Dec. rebuilding in Haiti; excluding these countries, Caribbean Mexico 10 growth in the Caribbean is projected to be 2¼ Sources: CEIC EMED database; Haver Analytics; IMF, Balance of Payments Statistics; percent. Nonetheless, the constraints on policy IMF, Direction of Trade Statistics; national sources; and IMF staff estimates. 1Caribbean: Antigua and Barbuda, the Bahamas, Barbados, Belize, Dominica, Dominican stemming from high public debt levels mean that Republic, Grenada, Guyana, Haiti, Jamaica, St. Kitts and Nevis, St. Lucia, St. Vincent and the outlook for these countries remains closely tied the Grenadines, Suriname, and Trinidad and Tobago; financially integrated commodity exporters (FICE): Brazil, Chile, Colombia, Peru, and Uruguay; Other Latin America (Other to external developments. LA): Argentina, Bolivia, Costa Rica, Ecuador, El Salvador, Guatemala, Honduras, Nicaragua, There are risks to this forecast in both directions. Panama, Paraguay, and Venezuela; LAC: Caribbean, FICE, Other LA, and Mexico. Aggregates for the external economy are sums of individual country data. Aggregates for allIn the near term, strong commodity export prices others are computed on the basis of purchasing-power-parity weights. 2 Emerging Asia comprises Hong Kong SAR, Indonesia, Korea, Malaysia, Philippines,and capital ﬂows present upside risks to growth. Singapore, Taiwan Province of China, Thailand, and Vietnam. 3 Other LA excludes Honduras, Nicaragua, and Panama due to data limitations.But these favorable conditions could also be triggers International Monetary Fund | April 2011 77

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERY Table 2.5. Selected Western Hemisphere Economies: Real GDP, Consumer Prices, Current Account Balance, and Unemployment (Annual percent change unless noted otherwise) Real GDP Consumer Prices1 Current Account Balance2 Unemployment3 Projections Projections Projections Projections 2010 2011 2012 2010 2011 2012 2010 2011 2012 2010 2011 2012 North America 3.1 2.9 3.0 1.9 2.3 1.8 –3.0 –3.1 –2.7 ... ... ... United States 2.8 2.8 2.9 1.6 2.2 1.6 –3.2 –3.2 –2.8 9.6 8.5 7.8 Canada 3.1 2.8 2.6 1.8 2.2 1.9 –3.1 –2.8 –2.6 8.0 7.6 7.3 Mexico 5.5 4.6 4.0 4.2 3.6 3.1 –0.5 –0.9 –1.1 5.4 4.5 3.9 South America 6.5 4.8 4.2 6.7 7.8 7.1 –1.1 –1.3 –1.8 ... ... ... Brazil 7.5 4.5 4.1 5.0 6.3 4.8 –2.3 –2.6 –3.0 6.7 6.7 6.7 Argentina4 9.2 6.0 4.6 10.5 10.2 11.5 0.9 0.1 –0.5 7.7 9.0 8.5 Colombia 4.3 4.6 4.5 2.3 3.6 2.8 –3.1 –2.1 –2.2 11.8 11.5 11.0 Venezuela –1.9 1.8 1.6 28.2 29.8 31.3 4.9 7.0 6.3 8.6 8.1 8.6 Peru 8.8 7.5 5.8 1.5 2.7 3.2 –1.5 –2.1 –2.8 8.0 7.5 7.5 Chile 5.3 5.9 4.9 1.5 3.6 3.2 1.9 0.5 –1.3 8.3 7.2 7.2 Ecuador 3.2 3.2 2.8 3.6 3.5 3.2 –4.4 –4.0 –4.0 7.6 7.3 7.5 Uruguay 8.5 5.0 4.2 6.7 7.2 6.0 0.5 –1.0 –1.6 7.0 6.9 6.8 Bolivia 4.2 4.5 4.5 2.5 10.4 5.4 4.8 3.8 4.4 ... ... ... Paraguay 15.3 5.6 4.5 4.7 9.6 9.0 –3.2 –4.1 –3.7 6.1 5.9 5.5 Central America5 3.6 4.0 4.3 3.9 5.5 5.3 –5.1 –6.4 –6.6 ... ... ... Caribbean6 3.4 4.2 4.5 7.1 7.2 5.9 –3.9 –4.0 –2.5 ... ... ... Memorandum Latin America and the Caribbean7 6.1 4.7 4.2 6.0 6.7 6.0 –1.2 –1.4 –1.8 ... ... ... 1Movements in consumer prices are shown as annual averages. December–December changes can be found in Tables A6 and A7 in the Statistical Appendix. 2Percent of GDP. 3Percent. National definitions of unemployment may differ. 4Private analysts estimate that consumer price inflation has been considerably higher than the official estimates from 2007 onward. The Argentine authorities have announced that they are developing a national consumer price index (CPI) to replace the Greater Buenos Aires CPI currently in use. At the request of the authorities, the IMF is providing technical assistance in this effort. Private analysts are also of the view that real GDP growth was significantly lower than the official estimates in 2008 and 2009, although the discrepancy between private and official estimates of real GDP growth narrowed in 2010. 5Central America comprises Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua, and Panama. 6The Caribbean comprises Antigua and Barbuda, The Bahamas, Barbados, Belize, Dominica, Dominican Republic, Grenada, Guyana, Haiti, Jamaica, St. Kitts and Nevis, St. Lucia, St. Vincent and the Grenadines, Suriname, and Trinidad and Tobago. 7Includes Mexico and economies from the Caribbean, Central America, and South America. for demand and credit booms in a number of LAC risk aversion or unexpectedly rapid increases in U.S. economies. If unchecked, these could lead to an interest rates could lead to a sharp reversal in capital eventual bust. This pattern of near-term upside risk flows, although the experience during the recent leading to medium-term downside risk is reinforced turmoil in the euro area periphery suggests that through the region’s internal and external link- such disruptions are unlikely to be overwhelming. ages. Because of Brazil’s systemic importance to the Macroeconomic policies in the region should not region, many neighboring countries are currently fall behind the curve, given the risk of overheat- benefiting from its strong growth. Conversely, an ing. In countries where currencies are not under abrupt slowdown of economic activity in Brazil strong upward pressure on the back of strong capital would adversely affect the region. A related risk is flows and where monetary policy is still expansion- that a potential hard landing in China would bring ary, policy rates should move faster toward more a sharp drop in the prices of the region’s commodity neutral levels. However, much of the focus should exports, dampening growth prospects. If a spike in be on fiscal policies, particularly given the historical oil prices were to dampen global growth, this could tendency throughout the region to adopt procycli- also be a trigger for a drop in the region’s commod- cal policies. In the FICE, this need stems from the ity exports. Finally, another bout of higher global pressure of strong capital flows, already-elevated78 International Monetary Fund | April 2011

CHAPTER 2 COUNTRY AND REGIONAL PERSPECTIVESexchange rates, and monetary policy rates that are capital inflows. While a number of countries in thehigher than in other countries. In other countries, region have been quite active on this front recently,it is important to reduce debt burdens and regain introducing prudential measures (see Figure 1.15),room for fiscal mobility. Exchange rates should more work remains to be done. Policies shouldbe allowed to continue to act as shock absorbers ensure that capital flows are directed toward longer-in the face of pressure stemming from economic term financing and that balance sheet exposures areconditions in the region that have improved more actively and prudently managed.than those in more advanced economies, primarilybecause of terms-of-trade gains from high commod-ity export prices. Growth Has Returned to Precrisis Rates in Macroprudential policies need to focus on Many African Countriesmaintaining and enhancing the resilience of these Sub-Saharan Africa has recovered well from the globaleconomies to potential problems from accelerating financial crisis (Figure 2.13), and the region is nowdomestic credit and significant capital flows. This second only to developing Asia in its rate of expansion.is most imperative in the FICE, but such policy Output gaps in many of the region’s economies are startingimprovements will also benefit other regional econo- to close, although South Africa is a notable exception.mies. As with macroeconomic policies, these need The region grew rapidly last year. Domesticto be implemented in a forward-looking manner to demand growth remained robust, trade and com-stem potential credit growth excesses and sustained modity prices rebounded, and macroeconomic poli- Figure 2.13. Sub-Saharan Africa: Average Projected Real GDP Growth during 2011–12 (Percent) Below 0 Between 0 and 2 Between 2 and 4 Above 4 Insufficient data Covered in a different map Source: IMF staff estimates. International Monetary Fund | April 2011 79

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERY Figure 2.14. Sub-Saharan Africa: Back to Precrisis cies continued to be accommodative (Figure 2.14). Growth1 Terms-of-trade gains are supporting the region’s external balances, and the gradual reorientation of exports toward faster-growing regions such as Asia Growth in most economies, particularly the low-income countries, is back to precrisis rates. Recovery has been helped by strong domestic demand, stable has been sustained. financial flows, and terms-of-trade gains from strong commodity prices, which have Against this backdrop, real activity in sub-Saharan also improved the region’s external balance. As output gaps close, fiscal policy needs to stay countercyclical. Africa is projected to expand by 5½ percent this year and 6 percent next year. Within the region, however, 15 Contribution to Growth 2 Net Financial Flows 160 prospects diﬀer considerably. (percent change) (billions of U.S. dollars) 12 Remittances 140 • Growth in the region is being led by the low- 9 Public aid 120 income countries (LICs), which are projected to 6 Private direct investment Private portfolio flows 100 expand by 6 percent this year (Table 2.6). Ghana— 3 80 0 which, following a substantial upward revision to 60 -3 its national accounts, is now the third-largest LIC GDP growth 40 -6 -9 Private consumption 20 in the region—is projected to grow by 13¾ percent Public consumption -12 Investment 0 this year, as oil production commences in the Jubi- -15 Net exports -20 Discrepancy lee oilfield and growth in the non-oil sector remains -18 -40 2004 06 08 10 12 2004 06 08 10 12 robust. The recovery in other LICs, such as Kenya and Ethiopia, is also expected to stay strong this 180 Terms of Trade Current Account 9 year, supported by infrastructure investment and (2004 = 100) (percent of SSA’s total GDP) Oil exporters SSA improving agricultural production. 160 Low-income LICs 6 countries Oil exporters • The expected strengthening of oil prices in 2011 (LICs) MICs 140 3 will help sustain the recovery in the region’s oil SSA exporters. Following the sharp rebound in oil 120 0 production last year in Nigeria, oil output is expected to stabilize this year, and the economy 100 -3 Middle-income is set to expand by 7 percent. Most other oil- countries (MICs) exporting economies are planning to use the 80 -6 2004 06 08 10 12 2004 06 08 10 12 buoyancy of global oil markets as an opportunity to return to fiscal surpluses and rebuild reserves, 5 Output Gap Fiscal Net Lending/Borrowing 15 (percent of potential GDP) (percent of GDP) but fiscal policy remains procyclical in Nigeria 4 MICs 10 due to the failure to adhere to the oil-price-based 3 Oil exporters fiscal rule, which links spending to long-term 2 5 average oil prices. SSA SSA 1 • In marked contrast to the robust growth in most LICs Oil exporters 0 0 of the region, recovery is expected to be relatively LICs -1 -5 weak in South Africa, the region’s largest economy. -2 MICs Despite an already sizable output gap, South -3 2004 06 08 10 12 2004 06 08 10 12 -10 Africa is expected to grow by only 3½ percent in 2011—a rate that is insufficient to reverse the Source: IMF staff estimates. substantial job losses of the past two years. The 1 Aggregates for the external economy are sums of individual country data. Aggregates for outlook primarily reflects the lack of strong domes- terms of trade are weighted by the country’s trade share in the group. Aggregates for all others are computed on the basis of purchasing-power-parity weights. tic demand, as private investment is held back by 2 Excludes Liberia and Zimbabwe due to data limitations. excess capacity. Risks to the region’s growth outlook remain tilted to the downside. Despite the increasing importance of Asia, Europe remains a much larger trading80 International Monetary Fund | April 2011

CHAPTER 2 COUNTRY AND REGIONAL PERSPECTIVESTable 2.6. Selected Sub-Saharan African Economies: Real GDP, Consumer Prices, Current AccountBalance, and Unemployment(Annual percent change unless noted otherwise) Real GDP Consumer Prices1 Current Account Balance2 Unemployment3 Projections Projections Projections Projections 2010 2011 2012 2010 2011 2012 2010 2011 2012 2010 2011 2012Sub-Saharan Africa 5.0 5.5 5.9 7.5 7.8 7.3 –2.4 0.4 0.4 ... ... ... Oil Exporters 6.5 6.9 7.0 12.4 10.8 9.4 2.6 10.9 11.1 ... ... ... Nigeria 8.4 6.9 6.6 13.7 11.1 9.5 6.4 14.6 13.3 4.5 4.5 4.5 Angola 1.6 7.8 10.5 14.5 14.6 12.4 –1.8 6.2 9.5 ... ... ... Equatorial Guinea –0.8 7.2 4.0 7.5 7.3 7.0 –23.8 –10.2 –9.0 ... ... ... Gabon 5.7 5.6 3.3 0.6 2.3 3.4 11.8 17.0 15.3 ... ... ... Republic of Congo 9.1 7.8 4.7 5.0 5.9 5.2 2.7 12.5 16.0 ... ... ... Chad 5.1 4.1 6.0 1.0 3.0 3.0 –21.3 –8.0 –6.1 ... ... ... Middle-Income 3.1 3.7 4.0 4.4 5.2 5.8 –3.1 –4.5 –5.1 ... ... ... South Africa 2.8 3.5 3.8 4.3 4.9 5.8 –2.8 –4.4 –5.1 24.8 24.4 23.7 Botswana 8.6 6.0 6.6 6.9 7.8 7.0 –2.5 –2.4 –0.0 ... ... ... Mauritius 4.0 4.1 4.2 2.9 7.4 4.6 –9.5 –11.6 –9.6 7.5 7.8 7.9 Namibia 4.4 4.8 4.5 4.5 5.9 5.6 –1.1 –0.9 –3.3 ... ... ... Swaziland 2.0 0.5 1.5 4.5 7.9 6.1 –20.6 –16.0 –12.9 25.0 25.0 25.0 Cape Verde 5.4 5.5 6.8 2.1 4.4 5.4 –11.8 –18.0 –15.7 ... ... ... Low-Income4 5.3 5.9 6.5 6.2 7.5 6.8 –7.0 –7.1 –6.7 ... ... ... Ethiopia 8.0 8.5 8.0 2.8 12.9 11.2 –4.3 –8.1 –8.1 ... ... ... Kenya 5.0 5.7 6.5 3.9 7.2 5.0 –7.9 –9.3 –7.9 ... ... ... Ghana 5.7 13.7 7.3 10.7 8.7 8.7 –7.2 –6.8 –5.2 ... ... ... Tanzania 6.5 6.4 6.6 10.5 6.3 7.0 –8.6 –9.5 –10.7 ... ... ... Cameroon 3.0 3.5 4.5 1.3 3.0 2.5 –3.9 –3.1 –3.0 ... ... ... Uganda 5.2 6.0 6.5 9.4 6.1 11.0 –9.9 –10.6 –9.2 ... ... ... Côte d’Ivoire5 2.6 –7.5 6.0 1.4 5.0 2.5 3.9 ... ... ... ... ... 1Movements in consumer prices are shown as annual averages. December–December changes can be found in Table A7 in the Statistical Appendix. 2Percent of GDP. 3Percent. National definitions of unemployment may differ. 4Includes Benin, Burkina Faso, Burundi, Central African Republic, Comoros, Democratic Republic of Congo, Eritrea, The Gambia, Ghana, Guinea, Guinea-Bissau, Lesotho,Liberia, Madagascar, Malawi, Mali, Mozambique, Niger, Rwanda, São Tomé and Príncipe, Senegal, Seychelles, Sierra Leone, Togo, Zambia, and Zimbabwe. 5Current account projections are not shown due to the uncertain political situation.partner for the region’s non-oil-exporting economies. The focus of fiscal policy should therefore turn toA slowdown in Europe would particularly hurt the medium-term priorities, while monetary policy needsregion’s manufacturing exporters, such as South to be increasingly alert to the inflation outlook.Africa. In addition, a sharper-than-expected pickup • The active use of countercyclical fiscal policy toin fuel and food prices could adversely affect many of support output during the crisis has left a legacy ofthe region’s oil-importing economies. This could have wider fiscal deficits across the region. With growthmajor social and fiscal costs in the LICs. Another in many economies now approaching potential,risk factor is politics. In some economies, such as financing and medium-term debt sustainabilityCôte d’Ivoire, political turmoil has already dampened considerations mostly point to the need to revisitgrowth prospects for 2011. But beyond that, with medium-term trajectories for government spending2011 shaping up to be a busy year politically—with and revenue. At the same time, fiscal buffers needas many as 17 national elections scheduled—activity to be rebuilt and fiscal room needs to be found forin some countries could be hindered by related politi- spending priorities such as health, education, andcal unrest. infrastructure. Such adjustments are already under Narrowing output gaps, alongside an incipient way in, for example, South Africa. In Nigeria,rekindling of inflation pressures by rising commodity however, where growth is much stronger, the fiscalprices, mean that policies to support demand are no stance has weakened and fiscal consolidation islonger appropriate except in a handful of economies. overdue; anchoring fiscal policy through a strong International Monetary Fund | April 2011 81

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERY oil-revenue-based rule would help maintain a coun- and control of government spending, including tercyclical fiscal stance. infrastructure investment. • Rising food prices are likely to affect the urban poor in particular, given the high share of food in their consumption baskets. In response, governments The Recovery in the Middle East and North will need to consider targeted social safety nets— Africa Region Faces an Uncertain Environment another reason to create greater room for fiscal The MENA region weathered the global crisis policy maneuvering. At the same time, policymakers relatively well, and while the recovery is now proceed- should remain alert to inflation pressure from rising ing, economic growth varies widely across the region. commodity prices, especially with limited spare Spreading social unrest, rising sovereign risk premiums, capacity in many economies. For South Africa and and elevated commodity import prices will constrain a number of middle-income countries where output growth prospects in several MENA economies. Although remains well below potential, however, continued economic prospects across the MENA region are quite monetary accommodation will be appropriate. diverse, an ongoing regionwide repricing of risk is push- Finally, a number of other policy areas require ing up borrowing costs. sustained attention. More intensive monitoring Higher commodity prices and external demand are and sounder regulation of the ﬁnancial sector are boosting production and exports in many econo- needed, as are continuing improvements to the mies in the region. In addition, government spend- business environment. Robust public ﬁnancing ing programs are continuing to foster recovery in mechanisms would also facilitate better planning many oil-exporting economies. At the same time, Figure 2.15. Middle East and North Africa: Average Projected Real GDP Growth during 2011–12 (Percent) Below 0 Between 0 and 2 Between 2 and 4 Above 4 Insufficient data Covered in a different map Source: IMF staff estimates. Note: Projections are not provided for Libya due to the uncertain political situation.82 International Monetary Fund | April 2011

CHAPTER 2 COUNTRY AND REGIONAL PERSPECTIVESTable 2.7. Selected Middle East and North African Economies: Real GDP, Consumer Prices, CurrentAccount Balance, and Unemployment(Annual percent change unless noted otherwise) Real GDP Consumer Prices1 Current Account Balance2 Unemployment3 Projections Projections Projections Projections 2010 2011 2012 2010 2011 2012 2010 2011 2012 2010 2011 2012Middle East and North Africa 3.8 4.1 4.2 6.9 10.0 7.3 6.5 12.7 11.2 ... ... ... Oil Exporters4 3.5 4.9 4.1 6.7 10.6 7.1 9.2 16.9 15.0 ... ... ... Islamic Republic of Iran 1.0 –0.0 3.0 12.5 22.5 12.5 6.0 11.7 10.4 ... ... ... Saudi Arabia 3.7 7.5 3.0 5.4 6.0 5.5 8.7 19.8 13.8 10.5 ... ... Algeria 3.3 3.6 3.2 4.3 5.0 4.3 9.4 17.8 17.4 10.0 9.8 9.5 United Arab Emirates 3.2 3.3 3.8 0.9 4.5 3.0 7.7 10.4 10.5 ... ... ... Qatar 16.3 20.0 7.1 –2.4 4.2 4.1 18.7 36.1 34.0 ... ... ... Kuwait 2.0 5.3 5.1 4.1 6.1 2.7 31.8 39.4 39.4 1.6 1.6 1.6 Iraq 0.8 9.6 12.6 5.1 5.0 5.0 –6.2 –3.2 –0.7 ... ... ... Sudan 5.1 4.7 5.6 13.0 9.0 7.0 –8.5 –5.5 –6.6 13.7 12.6 11.4 Oil Importers5 4.5 1.9 4.5 7.6 8.1 8.0 –3.8 –5.2 –4.5 ... ... ... Egypt 5.1 1.0 4.0 11.7 11.5 12.0 –2.0 –2.7 –2.3 9.2 9.2 9.1 Morocco 3.2 3.9 4.6 1.0 2.9 2.9 –4.2 –5.7 –4.1 9.0 8.9 8.7 Syrian Arab Republic 3.2 3.0 5.1 4.4 6.0 5.0 –4.4 –4.6 –4.8 8.4 ... ... Tunisia 3.7 1.3 5.6 4.4 4.0 3.3 –4.8 –7.8 –5.8 13.0 14.7 14.4 Lebanon 7.5 2.5 5.0 4.5 6.5 3.0 –10.2 –12.9 –12.8 ... ... ... Jordan 3.1 3.3 3.9 5.0 6.1 5.6 –5.4 –8.5 –8.7 12.5 12.5 12.5MemorandumIsrael 4.6 3.8 3.8 2.7 3.0 2.5 3.1 3.3 3.1 6.7 5.5 5.0Maghreb6 3.5 3.3 4.1 3.2 4.2 3.7 5.3 7.2 7.6 ... ... ...Mashreq7 5.0 1.5 4.2 9.6 10.0 9.8 –3.6 –4.7 –4.4 ... ... ... 1Movements in consumer prices are shown as annual averages. December–December changes can be found in Tables A6 and A7 in the Statistical Appendix. 2Percent of GDP. 3Percent. National definitions of unemployment may differ. 4Includes Bahrain, Libya, Oman, and Republic of Yemen. Excludes Libya for the projection years due to the uncertain political situation. 5Includes Djibouti and Mauritania. 6The Maghreb comprises Algeria, Libya, Mauritania, Morocco, and Tunisia. Excludes Libya for the projection years due to the uncertain political situation. 7The Mashreq comprises Egypt, Jordan, Lebanon, and Syrian Arab Republic.political discontent, high unemployment, and rising Republic of Iran, growth in 2011 is expected tofood prices are causing social unrest in a number of stall temporarily as subsidies for energy and othercountries, which is likely to dampen their short-term products are phased out—a much-needed reformgrowth. that will yield benefits in the medium term. Taking into account these factors, GDP in the Disruption of oil production in Libya meansMENA region is projected to grow at 4 percent in that, given constraints on non-OPEC capacity,2011, edging up to about 4¼ percent in 2012. As in oil production from other OPEC suppliers willother regions, recovery prospects vary substantially increase in 2011.across MENA economies (Figure 2.15; Table 2.7). • In the group of oil importers, Egypt’s GDP growth• In the group of oil exporters, growth is expected will fall significantly below the 5½ percent reg- to pick up to 5 percent this year. The strongest istered in the second half of 2010. This assumes performer is Qatar, where real activity is projected a modest dampening effect on economic activity to expand by 20 percent in 2011, underpinned from the political turmoil: disruptions to tourism, by continued expansion in natural gas produc- capital flows, and financial markets are expected tion and large investment expenditures. In Saudi to be temporary. In Tunisia, growth is projected Arabia, GDP is expected to grow at about 7½ to slow to 1¼ percent in 2011, as the expected percent this year, supported by sizable govern- decline in tourism and foreign direct investment ment infrastructure investment. In the Islamic harms other sectors of the economy. International Monetary Fund | April 2011 83

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERY Figure 2.16. Middle East and North Africa: As in other regions, inflation is on the rise in the 1 The Recovery Continues in an Uncertain Environment MENA region, as higher commodity prices lift headline inflation (Figure 2.16). For the region as a whole, con- Having weathered the global crisis relatively well, the recovery is now proceeding. sumer price inflation is projected to increase to about The level of economic activity is still below but getting closer to potential. High unemployment, growing social unrest, and rising food prices are dampening growth 10 percent in 2011, led by the Islamic Republic of Iran, prospects, especially in oil-importing economies. Current account surpluses in where fuel subsidies are being substantially reduced. oil-exporting economies are expected to widen again as the recovery continues. The key risks to this outlook are to the downside. 5 Output Gap Inflation 16 Depending on its duration and intensity, the domestic (percent of potential GDP) (percent) 4 Oil exporters 14 effects of political and social turmoil could be larger 3 Oil exporters than currently expected, particularly if sustained unrest 2 MENA 12 MENA spills over to additional countries in the region. Finan- 1 10 0 cial markets have not been immune, and credit default -1 8 swap and bond spreads have already widened through- -2 Oil importers 6 out the region. If persistent, such financial market -3 Oil importers 4 developments could translate into higher funding -4 -5 2 costs for governments and firms. In addition, slower- 2000 02 04 06 08 10 12 2003 05 07 09 11 12 than-expected recovery in advanced economies would 50 2010 CPI Weights for Food2 Unemployment Rate3 35 adversely affect the region’s export earnings, fiscal and (percent) (percent) external balances, and growth. 30 40 Total Turning to the external sector, current account 25 Youth surpluses in the MENA region are expected to widen 30 20 again as the recovery proceeds, driven in part by 20 15 elevated energy export prices. The overall regional cur- 10 rent account surplus, which declined from 15 percent of 10 5 GDP in 2008 to 2¼ percent of GDP in 2009, is now projected to rise to over 12 percent of GDP in 2011. 0 0 The key policy challenges across the region are Saudi Arabia Iran, I.R. of U.A.E. Tunisia Lebanon Algeria Bahrain Jordan Qatar Egypt Oman Lebanon Egypt Jordan Tunisia daunting. For oil importers, the main priority is to raise growth and tackle chronically high unemploy- Current Account Balance Net Financial Flows ment, especially among young people. For oil exporters, 30 10 (percent of GDP) (percent of GDP) the focus should be to strengthen or develop financial Total Flows 5 systems and promote economic diversification. Recent 20 increases in public spending on non-energy-related MENA 0 sectors should be helpful in diversifying activity toward 10 -5 these sectors and rebalancing regional growth. -10 Fiscal policy has played a critical role in cushion- Direct investment 0 Private portfolio flows ing the impact of the global crisis on the region and Oil importers Other private flows -15 Official flows in supporting its recovery. Government investment Oil exporters -10 1992 96 2000 04 08 12 16 -20 programs, especially in infrastructure, will continue 2000 02 04 06 08 10 12 to boost domestic demand in the near term in many Sources: Haver Analytics; International Labor Organization; IMF, Primary Commodity oil-exporting economies. High debt levels, however, Price System; national sources; and IMF staff estimates. 1 Oil exporters: Algeria, Bahrain, Islamic Republic of Iran, Iraq, Kuwait, Libya, Oman, constrain the scope for fiscal maneuver in oil-import- Qatar, Saudi Arabia, Sudan, United Arab Emirates (U.A.E.), and Republic of Yemen. Oil importers: Djibouti, Egypt, Jordan, Lebanon, Mauritania, Morocco, Syrian Arab Republic, ing economies. Nevertheless, to shield populations and Tunisia. Aggregates for the external economy are sums of individual country data. from surging commodity prices, many economies have Aggregates for all others are computed on the basis of purchasing-power-parity weights. 2 Data for Algeria, Tunisia, and U.A.E. are for 2009. Data for Saudi Arabia are for 2008. recently increased food and fuel subsidies (Jordan, Data for Lebanon are for 2007. CPI: consumer price index. 3 Youth defined as persons ages 15 to 24 years. Data on youth unemployment rate are Kuwait, Tunisia), increased social transfers (Sudan, not available for Jordan. Syrian Arab Republic, Tunisia, Republic of Yemen),84 International Monetary Fund | April 2011

CHAPTER 2 COUNTRY AND REGIONAL PERSPECTIVESexpanded civil service employment or salaries (Egypt, With regard to financial sector policy, the prioritiesJordan, Saudi Arabia, Sudan, Republic of Yemen), and should vary across economies. For the more finan-introduced direct cash transfers (Bahrain, Kuwait). cially developed economies of the Gulf Cooperation In most MENA economies, chronically high unem- Council, the key task is to restore capital and liquid-ployment, especially among young people and the ity buffers used up during the crisis and to improveeducated, is a long-standing challenge that now must regulatory and supervisory regimes in line with globalbe tackled urgently. The fact that unemployment has efforts. This will help revive credit, which has beenremained high for so long suggests that the problem is sluggish partly due to still-weak banking and corporatelargely structural—stemming from skill mismatches, balance sheets following prominent corporate defaultslabor market rigidities, and high reservation wages. A (in Dubai, Kuwait, and Saudi Arabia, for example).lasting solution to the region’s unemployment problem For other economies in the region, the main challengewill require a combination of permanently higher and is to prevent a rise in nonperforming loans in countriesinclusive economic growth and reforms to improve the with unrest, to spur greater financial development byresponsiveness of labor markets.8 removing barriers to entry and exit and, in some cases, to reduce state banking system ownership. Addressing 8 See the IMF’s October 2010 and May 2011 Regional Economic the high number of nonperforming loans in a numberOutlook for the Middle East and Central Asia. of economies is another priority. International Monetary Fund | April 2011 85

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERY Box 2.1. Unwinding External Imbalances in the European Union Periphery The Great Recession forced a painful adjustment in rebounded and exports rose above their 2007 level, external imbalances in the periphery of the European possibly reflecting the decline in unit labor costs Union. Current account deficits soared in the years and the recovery in global trade. In terms of saving leading up to the crisis, with rapid growth in credit and investment, the adjustment has so far been due and domestic demand and strong increases in unit mainly to a contraction in investment. A decline in labor costs relative to the euro area. By 2007, the cur- public saving, mainly due to decreased government rent account deficit averaged 10.0 percent of GDP in revenue during the recession, has been partly offset Greece, Ireland, Portugal, and Spain and 17.7 percent by a rise in private saving to more sustainable levels. of GDP in the Baltic economies of Estonia, Latvia, and Lithuania. Because the nominal exchange rate is Greece, Ireland, Portugal, and Spain fixed, these economies have had to unwind the large A painful but more gradual process of external imbalances through demand contraction and a decline adjustment is under way in these economies. GDP in inflation and wage growth relative to their trading contracted by an average of 4.0 percent in 2009, partners, a process known as internal devaluation. To and the unemployment rate rose by an average of shed light on how this process is proceeding, this box compares the experience of the Baltics with that of the other economies and discusses some challenges ahead. Figure 2.1.1. Economic Activity and External Adjustment in the EU Periphery Estonia, Latvia, and Lithuania These Baltic economies have eliminated their cur- Greece Ireland Portugal rent account deficits, but the contraction in economic Spain Baltics1 activity has been unusually large. GDP contracted by an average of 15.5 percent in 2009, and the unem- 15 Real GDP Growth Unemployment Rate 25 ployment rate rose by 12.8 percentage points during (percent) (percent) 10 2007–10. In terms of external adjustment, these 20 5 economies’ current accounts swung from a deficit 0 15 averaging 17.7 percent of GDP in 2007 to a surplus averaging 5.8 percent of GDP in 2009, which may be -5 10 above the long-term level. Indeed, the current account -10 5 surplus declined in 2010, and the challenge is now -15 to sustain recent improvements in competitiveness -20 2000 02 04 06 08 10 2000 02 04 06 08 10 0 to support growth in productive sectors. Unit labor costs also fell sharply relative to the euro area, by 18.1 10 Current Account Unit Labor Cost 180 percent from their peak. The sharp rises in unemploy- Balance (2000:Q1 = 100) 5 (percent of GDP) 160 ment, as well as the flexibility of these economies’ labor markets and large cuts in both public sector and 0 140 private sector wages, accelerated internal devaluation -5 and the restoration of competitiveness. 120 -10 The sharp recession meant that the adjustment ini- 100 -15 tially occurred through a contraction of imports, but -20 80 exports subsequently contributed to the rebalancing. 2000 02 04 06 08 10 2000 02 04 06 08 10: Q4 In 2009, the ratio of imports to GDP fell by an average of 14.6 percentage points. In 2010, imports Sources: Haver Analytics; and IMF staff calculations. 1Baltics: Estonia, Latvia, and Lithuania. Aggregates for the Baltics are simple averages except for current account balance, The authors of this box are Florence Jaumotte and Daniel which is calculated as the sum of the balances. Leigh.86 International Monetary Fund | April 2011

CHAPTER 2 COUNTRY AND REGIONAL PERSPECTIVESBox 2.1 (continued)7.0 percentage points during 2007–10. The external Figure 2.1.2. External Adjustment in the EUadjustment process started later than in the Baltic Peripheryeconomies, with the ratio of the current accountdeficit to GDP falling by 4.3 percentage points—from10.7 percent of GDP in 2008 to 6.4 percent of GDP Change in Trade Balance, 2007–10 30in 2010. The current account deficits of Ireland and, (percent of GDP) Exports 20to a lesser extent, Spain have moved toward more Importssustainable levels, but they remain excessively large in Trade balance 10Greece and Portugal, at 10.4 and 9.9 percent of GDP, 0respectively, in 2010. The decline of unit labor costsrelative to the euro area averaged 5.1 percent for these -10economies, but this is skewed by the 10.2 percent -20decline in Ireland; the decline was more modest in the Greece Ireland Portugal Spain Baltics1other three countries. There are signs of a turnaround in all four of these Change in Current Account, 2007–10 (percent of GDP) Investment 40countries. They initially adjusted through import Public savings 30contraction, but exports started contributing to the Private savings Current account 20adjustment in 2010. Reflecting the smaller contrac-tion in income, the fall in the ratio of imports to 10GDP in 2009 was smaller than in the Baltics—an 0average of 4.8 percentage points compared with 14.6 -10percentage points. In 2010, there was a rebound -20in both imports and exports, but exports generally -30 Greece Ireland Portugal Spain Baltics1increased more, thus furthering the external adjust-ment process. Exports as a share of GDP rose by Sources: Haver Analytics; and IMF staff calculations.much more in Ireland, possibly reflecting the greater 1Baltics: Estonia, Latvia, and Lithuania. Aggregates for thedecline in unit labor costs there. In real terms, Baltics are calculated as sums of individual country data.exports grew strongly in Ireland, Portugal, and espe-cially Spain, largely as a rebound. In terms of savingand investment, the adjustment has so far consisted indexation mechanisms, and reducing dismissalmainly of a contraction in investment, as in the Bal- costs. In addition, building a national consensustic economies, and the large fall in public saving has so that the burden of the adjustment is sharedbeen partly offset by a rise in private saving. Wage broadly through wage moderation can help pre-moderation has played a relatively modest role in vent a protracted period of high unemployment.Greece, Portugal, and Spain, where labor markets are • Reforms to increase productivity growth also con-less flexible than in the Baltics. tribute to improving competitiveness. A number of policies can contribute to the • The fiscal consolidation under way to addressremaining adjustment that will be required, and these economies’ elevated government debt levelsmany are already being implemented. In Greece and will also contribute to the external adjustment. InIreland, they are an integral part of the authorities’ the short term, raising taxes or cutting govern-adjustment programs, which are supported by the ment spending improves the current accountinternational community. The policies include mea- balance by restraining domestic demand, includ-sures on both the supply side and the demand side ing imports. Over the medium term, it wouldof the economy: be helpful to create room to cut taxes, thereby• Labor cost adjustment can be facilitated by pro- supporting private investment and the supply side moting decentralized wage bargaining, removing of the economy. International Monetary Fund | April 2011 87

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERY References Update on Fiscal Exit Strategies,” IMF Working Paper 10/272 (Washington: International Monetary Fund). Baldacci, Emanuele, Giovanni Callegari, David Coady, Ding Dowling, Thomas, Marcello M. Estevão, and Evridiki Tsounta, Ding, Manmohan S. Kumar, Pietro Tommasino, and Jae- 2010, “The Great Recession and Structural Unemploy- joon Woo, 2010, “Public Expenditures on Social Programs ment,” United States: Selected Issues Paper, IMF Country and Household Consumption in China,” IMF Working Report No. 10/248 (Washington: International Monetary Paper 10/69 (Washington: International Monetary Fund). Fund). Bornhorst, Fabian, Nina Budina, Giovanni Callegari, Asmaa Estevão, Marcello M., and Evridiki Tsounta, 2011, “Has the Great ElGanainy, Raquel Gomez Sirera, Andrea Lemgruber, Recession Raised U.S. Structural Unemployment?” IMF Work- Andrea Schaechter, and Joong Beom Shin, 2010, “A Status ing Paper (Washington: International Monetary Fund).88 International Monetary Fund | April 2011

1 3 HAPTERCHAPTER OIL SCARCITY, GROWTH, AND GLOBAL IMBALANCES The persistent increase in oil prices over the past decade sibility that rising energy prices will spill over into suggests that global oil markets have entered a period core inflation is just one example. But how unusual of increased scarcity. Given the expected rapid growth is the current situation? There are important linkages in oil demand in emerging market economies and a between global economic conditions and commodity downshift in the trend growth of oil supply, a return prices, and large fluctuations in commodity prices to abundance is unlikely in the near term. This chap- over the global cycle are nothing new.1 Cyclical fac- ter suggests that gradual and moderate increases in oil tors and special factors seem to explain much recent scarcity may not present a major constraint on global commodity price behavior. Nevertheless, persistent growth in the medium to long term, although the wealth commodity price increases in recent years point to transfer from oil importers to exporters would increase a break with the experience of the 1980s and 1990s capital flows and widen current account imbalances. as well as with the experience of earlier commodity Adverse effects could be much larger, depending on the price booms.2 Concern about resource scarcity is extent and evolution of oil scarcity and the ability of the more widespread now than a decade or two ago. world economy to cope with increased scarcity. Sud- This chapter considers the case of oil scarcity.3 The den surges in oil prices could trigger large global output main motivation is twofold. On the one hand, oil losses, redistribution, and sectoral shifts. There are two market prospects are central to the global economic broad areas for policy action. First, given the potential outlook—the oil price assumption is one of the key for unexpected increases in the scarcity of oil and other assumptions underlying the forecasts in the World resources, policymakers should review whether the current Economic Outlook (WEO). On the other hand, there policy frameworks facilitate adjustment to unexpected is considerable uncertainty about how strong the changes in oil scarcity. Second, consideration should be tension will be between rapid growth in oil demand given to policies aimed at lowering the risk of oil scarcity. in emerging market economies and the downshift in oil supply trends. The baseline oil market outlook After a year and a half of global recovery, natural discussed in Chapter 1, which is based on current resources are again in the headlines. The spot price oil market pricing, assumes that the tension will be of a barrel of Brent crude oil crossed the US$100 resolved with oil prices around current high levels. threshold in January 2011. The prices of many other Against this backdrop, this chapter analyzes the commodities have risen to meet or surpass their risks presented by several oil scarcity scenarios for precrisis peaks, and commodity futures markets the global outlook and the transition to a more point to further price increases in the next year or robust and balanced global expansion. As indicated two. Commodity price strength mirrors buoyancy by the emphasis on scarcity, the focus is on the on the demand side. Consumption levels of many medium to long term, not on short-term risks. natural resources, including crude oil, have already Specifically, this chapter seeks to answer the fol- risen above precrisis peaks, largely reflecting robust lowing questions: demand in emerging and developing economies. At current high levels, commodity price developments and prospects can have important global 1See Vansteenkiste (2009), Kilian (2009), or Helbling economic repercussions (see Chapter 1). The pos- (forthcoming). 2See, for example, Radetzki (2006), who notes that earlier The main authors of this chapter are Thomas Helbling (team commodity price booms in the post–World War II period were leader), Joong Shik Kang, Michael Kumhof, Dirk Muir, Andrea short-lived. Pescatori, and Shaun Roache, with support from Min Kyu Song, 3Appendix 2 of Chapter 1 provides an overview of recent Gavin Asdorian, Marina Rousset, and Nese Erbil. developments and prospects for other commodities. International Monetary Fund | April 2011 89

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERY • What is oil scarcity? How is it measured? What is appears to slow annual global growth by less than its current status? ¼ percent in the medium and longer term. On • Will oil scarcity constrain the global economy the other hand, a persistent decline in oil supply in the medium to longer term? What are the levels could have sizable negative effects on output risks that it will lower the feasible rate of global even if there is greater substitutability between growth? Could it widen global imbalances? oil and other primary energy sources. At the • What are the policy implications? same time, in the medium term, the oil-induced A discussion of oil scarcity faces the challenge of wealth transfer from oil importers to exporters can any forward-looking analysis. Experience to date increase capital flows, reduce the real interest rate, does not allow for strong predictions about the likely and widen current account imbalances. evolution of some of the factors that will determine • The analysis in this chapter suggests that oil scar- the eventual extent and impact of oil scarcity. For city will not inevitably be a strong constraint on example, technological developments will be crucial. the global economy. However, the risks it poses These will affect the cost of extracting oil from should not be underestimated either. Much will reservoirs or deposits so far deemed uneconomical ultimately depend on the extent and evolution and will define the scope for efficiency and substitu- of oil scarcity, which remain uncertain. There is tion. In the face of such uncertainty, which increases a potential for abrupt shifts, which would have with the time horizon, the key objective of this much larger effects than more gradual shifts. chapter is to illustrate the potential global economic • The chapter concludes that policymakers should impact of various oil scarcity scenarios. At the same strengthen measures to reduce the risks from oil time, it marks the beginning of renewed efforts scarcity as a precautionary step and to facilitate to give greater consideration to the role of oil and adjustment if such shifts are larger than expected other natural resources in the IMF’s modeling of the or materialize in an abrupt manner. Policies need global economy, both as the source of shocks and in to be complemented with efforts to strengthen the transmission of other shocks. social safety nets, because higher oil prices could lead to shifts in income distribution and to increased poverty. What Are the Main Findings? This chapter is organized as follows. The first • The increases in the trend component of oil prices section defines oil scarcity, considers the extent of suggest that the global oil market has entered scarcity in the oil sector, and discusses the implica- a period of increased scarcity. The analysis of tions for the oil market outlook. The second section demand and supply prospects for crude oil sug- examines the effects of oil scarcity on global growth gests that the increased scarcity arises from contin- and global imbalances to determine whether it will ued tension between rapid growth in oil demand constrain the global economy. The last section out- in emerging market economies and the downshift lines some policy implications. in oil supply trend growth. If the tension intensi- fies, whether from stronger demand, traditional supply disruptions, or setbacks to capacity growth, Has Oil Become a Scarce Resource? market clearing could force price spikes, as in The implications of oil scarcity could be impor- 2007–08. tant and far-reaching. Oil is a key factor of pro- • As for the effects on the global economy, the duction, including in the production of other simulation analysis suggests that the impact of commodities and in transportation, and is also a increased oil scarcity on global growth could be widely used consumption good. Oil is the most relatively minor if it involves primarily a gradual traded commodity, with world exports averaging downshift in oil supply growth rather than an US$1.8 trillion annually during 2007–09, which absolute decline. In particular, a sizable downshift amounted to about 10 percent of total world exports in oil supply trend growth of 1 percentage point in that period. This means that changes in oil90 International Monetary Fund | April 2011

CHAPTER 3 OIL SCARCITY, GROWTH, AND GLOBAL IMBALANCESmarket conditions have direct and indirect effects on Declining oil availability typically reflects tech-the global economy, including on growth, inflation, nological and geological constraints or a shortfallexternal balances, and poverty. Since the late 1990s, in the required investment in capacity. Oil scarcityoil prices have generally risen—notwithstanding can be exacerbated by its low substitutability. Oilcyclical fluctuations—and supply constraints are has unique physical properties that make rapidwidely perceived to have contributed to this trend. substitution difficult, meaning that the price may beThis has raised concerns that the oil market is enter- determined largely by supply capacity. In contrast, ifing a period of increased scarcity. other, more abundant natural or synthetic resources can eventually replace oil in the production process, then relatively small increases in prices may redirectWhat Is Oil Scarcity? demand toward these substitutes. Oil is considered scarce when its supply falls shortof a specified level of demand. If supply cannot meetdemand at the prevailing price, prices must rise to How Do We Measure Scarcity?encourage more supply and to ration demand. In this The following analysis focuses on long-term oilsense, oil scarcity is reflected in the market price. price developments as an indicator of scarcity and The price should reflect the opportunity cost of ignores short-term or periodic fluctuations such asbringing an additional barrel of oil to market. It com- the business cycle. Oil prices may also be subject topensates the reserve owner for the cost of extraction “super cycles” caused by long implementation lagsand for the loss of one barrel of reserves that could for discovery, exploration, and capital investment inhave been sold in the future. In general, a high price minerals industries (Cuddington and Jerrett, 2008).level relative to the prices of other goods and services Sluggish supply responses to shifts in demand canindicates scarcity, a low price indicates abundance, then give rise to price cycles with a longer durationand changes in price over long periods signal changes than the typical two- to eight-year business cyclein scarcity. Well-known models of commodity extrac- (Slade, 1982).tion also imply that the market price generally serves Long-term variation is assessed by passing pricesas a reliable guide to the opportunity cost, including through two low-pass filters: the first filter excludesthe cost relative to expected future scarcity.4 all price fluctuations with a cycle period of less than In practice, it is important to distinguish between nine years (and therefore includes super cycles);scarcity and other reasons for high oil prices. Scar- the second considers periods of more than 30 yearscity usually refers to the declining availability of oil (Figure 3.1).5 Including super cycles generates moreor other exhaustible natural resources in the long volatility but similar long-term trends. To provideterm. However, oil scarcity in the sense of high and a broader perspective on energy markets, coal andincreasing oil prices can also arise for other reasons natural gas are included in the analysis. One notice-over shorter horizons. Temporary supply shocks, for able result is that real oil prices have not trendedexample, can lead to short-lived price spikes, as dur- persistently up or down throughout the sampleing the 1990–91 Gulf War. There can also be large period.6 Instead, prices have experienced slow-cyclical fluctuations in oil prices, which largely reflectthe interaction between cyclical—including some 5This analysis uses U.S. dollar price series deflated by the U.S.financial—factors and low short-term price elasticities consumer price index over sample periods with starting datesof demand and supply. going back to 1875. Low-frequency components were extracted by a Christiano-Fitzgerald (2003) asymmetric filter (see Appendix 3.1). 4Hotelling (1931) shows that the price increases for a nonre- 6In other words, real oil prices are stationary. Where pricesnewable resource should track the interest rate (possibly including are nonstationary, as in the case of natural gas, and follow a unita risk premium) if marginal extraction costs remain constant. root process, the drift, or long-term trend, is typically small. ThisWhen the market learns gradually that a resource is becoming is consistent with the findings of Cashin, McDermott, and Scottmore scarce (or abundant), its price may rise at a faster pace (or (2002), who note that trends in real commodity prices are smallremain flat or even decline). and dominated by price variability. International Monetary Fund | April 2011 91

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERY moving fluctuations around long-term averages. This suggests that periods of changing oil scarcity have been long-lasting but have come to an end, and that investment, technology, and discovery are eventually responsive to price signals.Figure 3.1. Energy Prices and Long-Term Price Trends Following a period of increasing abundance during the 15 years through 2000, an upturn in long- Following a period of increasing abundance during the 15 years through 2000, an term prices is evident across energy commodities. upturn in long-term prices is evident across energy commodities. The first principal component of the three filtered energy prices—which accounts for about two-thirds Price of total variance—confirms that the common factor Filter — 9+ years including super cycles Filter — 30+ years excluding super cycles in energy scarcity has been rising since 2000 and was not interrupted by the Great Recession (bottom 1.5 Crude Oil — I(0) 1 Natural Gas — I(1)1 2.0 right panel). 1.5 1.0 1.0 What Lies behind the Apparent Increase in Oil 0.5 0.5 Scarcity? 0.0 0.0 In the end, the signal from oil prices should -0.5 reflect expectations of scarcity that must be consid--0.5 ered in terms of underlying fundamentals. Under- -1.0 standing the signal from current market prices-1.0 -1.5 1875 1900 25 50 75 Oct. 1875 1900 25 50 75 Oct. requires considering the prospects for demand 2010 2010 and supply. Prospects for oil, as well as for other energy sources, are related strictly to primary energy 0.8 Coal — I(0) 1 Energy Commodities2 3 demand. Therefore, this section first considers oil in Crude oil the broader context of primary energy consumption 0.4 All energy 2 before focusing on the supply and demand prospects 0.0 1 for oil.-0.4 0 What are the prospects for overall energy consumption?-0.8 -1 Oil is the most important source of primary-1.2 -2 energy in the world, accounting for about 33 1875 1900 25 50 75 Oct. 1875 1900 25 50 75 Oct. 2010 2010 percent of the total; the other two main fossil fuels, coal and natural gas, account for 28 and 23 percent, Sources: Global Financial Data; IMF Primary Commodity Price System; and IMF staffcalculations. respectively.7 Renewable sources of energy are in a 1 U.S.-dollar-denominated commodity prices are deflated by the U.S. consumer price rapid growth phase, but they still account for only aindex in log deviations from the sample mean. Deviation between filtered components andprice is accounted for by noise, business cycle frequencies, and random walk drift where small fraction of primary energy supply.I(1). 2 First-principal component (standard deviation from mean) normalized to have unit The context for much of the current concernvariance. about oil scarcity is the increase in the growth rate of global primary energy consumption in the past decade (Figure 3.2, top panel). This acceleration 7See U.S. Energy Information Administration (EIA), Interna- tional Energy Outlook, 2009. Primary energy includes fossil fuels (coal, oil, natural gas); nuclear energy; and renewable energy (geothermal, hydropower, solar, wind).92 International Monetary Fund | April 2011

CHAPTER 3 OIL SCARCITY, GROWTH, AND GLOBAL IMBALANCESprimarily reflects an upward shift in the growth ofenergy consumption in China. As a result, China’sshare of world consumption of primary energy hasrisen rapidly (bottom panel), and China is now thelargest energy consumer in the world (InternationalEnergy Agency—IEA, World Energy Outlook, 2010). Future energy consumption will depend largelyon the impact of continued rapid GDP growthin China and other fast-growing emerging mar-ket economies. To gauge the prospects for energy Figure 3.2. Global Energy Demand, 1980–2008demand, the analysis in this section focuses on therelationship between per capita energy consumptionand per capita real income and is based on a simple The rapid increase in global primary energy consumption, particularly in China, has raised concerns about oil scarcity.regression using a data set for 55 economies during1980–2008 (see Appendix 3.2 for details). Growth Rate of Primary Energy Consumption The estimates suggest that the relationship (percent) China Rest of world 6between per capita energy consumption and per FSU1 Worldcapita GDP is nonlinear. High-income economies 4can sustain GDP growth with little if any increasein energy consumption. Indeed, for some countries 2in the Organization for Economic Cooperation andDevelopment (OECD), energy consumption has 0been flat in recent years (Figure 3.3). In contrast, inlow- and middle-income economies energy demand -2 1980 84 88 92 96 2000 04 08growth has closely followed growth in per capitaincome. The income elasticity of energy demand is Share of Primary Energy Consumption 35close to unity: a 1 percent increase in real per capita (percent)GDP is associated with a 1 percent increase in per 30capita energy consumption. The experience of Korea United States 25exemplifies this one-to-one relationship. China’s Europe 20energy demand has so far closely followed this pat- FSU1 15tern (Figure 3.4). China 10 Given the empirical relationship estimated above Japan 5and the most recent WEO forecast for China’s India and Middle East 0per capita GDP, at current energy prices energy 1980 84 88 92 96 2000 04 08consumption in China is projected to double by2017 and triple by 2025 from its 2008 level. But Source: International Energy Agency. 1 FSU = former Soviet Union.it remains to be seen whether China will be ableto sustain such rapid growth. In fact, unlike Korea,China affects world market prices for primary energysources, and rising prices might restrain economicgrowth and/or lead to a downward shift in the rela-tionship between energy and income.What are the prospects for oil demand? GDP growth has been a major driver of oildemand in emerging market economies. Figure International Monetary Fund | April 2011 93

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERYFigure 3.3. Relationship between per Capita Energy 3.5 shows how per capita oil consumption in theConsumption and GDP Growth United States and other OECD economies has been(Hundred thousands of 2005 U.S. dollars on x-axis; billions of British broadly flat since the early 1980s, while it has risenthermal units on y-axis) rapidly in China. As a result, China’s share in global oil consumption rose from 6 percent in 2000 to Energy demand growth has closely followed growth in per capita income in low- and middle-income economies, whereas high-income economies can sustain GDP close to 11 percent in 2010. However, starting from growth with little if any increase in energy consumption. a lower base, China’s oil consumption is still only High-Income OECD Countries1 0.5 half as large as that of the United States (bottom Per capita energy consumption panel).8 Norway Canada 0.4 To gauge oil scarcity prospects, we first estimate United States oil consumption elasticities using a panel data Australia 0.3 approach.9 Specifically, per capita oil consumption is Sweden Netherlands Germany 0.2 regressed on its lagged value, real oil prices in local Switzerland currency, a polynomial in real per capita GDP levels, Japan United Kingdom0.1 0.2 0.3 0.4 0.5 0.1 the GDP growth rate, and a set of fixed effects PPP-weighted per capita GDP2 (see Appendix 3.2). The data set starts in 1990 Selected Middle-Income Economies 0.5 and includes 45 countries. The sample is divided Per capita energy consumption into two groups, loosely named OECD and Non- 0.4 OECD. Together, the two groups represented 84 0.3 percent of world oil consumption in 2009. (In addi- Malaysia Korea Taiwan Province of China tion, Appendix 3.2 examines a group of nine major 0.2 Hong Kong SAR oil-exporting economies and extends the sample to Thailand 0.1 1965.)10 Turkey Mexico The combined results for OECD and Non- 0.00.0 0.1 0.2 0.3 0.4 0.5 PPP-weighted per capita GDP2 OECD countries suggest very low short-term price elasticity, about –0.02 (Table 3.1).11 This implies Other Emerging Market Economies 0.15 Per capita energy consumption that a 10 percent increase in oil prices leads to a reduction in oil demand of only 0.2 percent. 0.10 Although the long-term price elasticity is about four Chile Argentina 8In 2008, coal accounted for 71 percent of total energy India 0.05 Brazil consumption in China, and oil and gas for only 19 and 3 percent, Indonesia respectively. This is in contrast with the United States, where oil Philippines 0.00 and gas accounted for 37 and 23 percent of total energy, respec-0.00 0.05 0.1 0.15 PPP-weighted per capita GDP2 tively, and coal for 22 percent (U.S. EIA, International Energy Outlook, 2008). 9Other studies have attempted to estimate oil demand elastici- Oil-Exporting Economies 1.2 Per capita energy consumption Qatar ties, such as Dargay and Gately (1995, 2010); Dargay, Gately, 1.0 and Huntington (2007); Gately and Hillard (2002); Huntington United Arab Emirates 0.8 (2002); and Cooper (2003), among others. Our framework is different, at least with respect to the sample period chosen, defini- 0.6 Bahrain tion of country groups, and the overall econometric specification. 0.4 10The multicountry dimension helps overcome the downward Iran, I.R. of bias problem that often arises when estimating demand price Kuwait 0.2 Saudi Arabia elasticities. Appendix 3.2 discusses identification issues in greater Venezuela 0.0 detail and presents robustness checks.0.0 0.2 0.4 0.6 0.8 1.0 11The combined elasticities are the weighted averages of the PPP-weighted per capita GDP2 group elasticities. The weights are the normalization of the last-10-year average oil consumption shares—which for OECD Sources: IMF, International Financial Statistics; International Energy Agency; World Bank, and Non-OECD countries stand at 0.55 and 0.31, respectively.World Development Indicators; and IMF staff calculations. Hence, the two groups combined represent 86 percent of world 1 OECD = Organization for Economic Cooperation and Development. 2 PPP = purchasing power parity. oil demand over the period.94 International Monetary Fund | April 2011

CHAPTER 3 OIL SCARCITY, GROWTH, AND GLOBAL IMBALANCEStimes larger, the number is still small, which impliesthat a 10 percent permanent increase in oil pricesreduces oil demand by about 0.7 percent after 20years. The short-term income elasticity is about 0.68,implying that a 1 percent increase in income isassociated with an increase in oil demand of 0.68percent. The long-term elasticity is considerablysmaller, at 0.29. This result indicates that oil con-sumption has been considerably less income-elasticthan primary energy demand, which means that the Figure 3.4. Primary Energy Consumptionworld economy has been (slowly) substituting away (Hundred thousands of 2005 U.S. dollars on x-axis; billions of Britishfrom oil.12 In addition, the fact that income elastic- thermal units on y-axis)ity is higher in the short term than in the long term There has been a broadly one-to-one relationship between growth in per capitasuggests that the response of oil consumption to an energy consumption and income in emerging market economies. China’sincome shock involves some cyclical overshooting. energy demand has so far closely followed this pattern.Initial responses, such as those during the global Predictedrecovery of 2009–10, therefore may not be represen- relationship 0.25 for Chinatative of longer-term trends. The growing importance of emerging mar- 0.20 Primary per capita energy consumptionket economies appears to have reduced world oildemand price elasticity (in absolute terms) andincreased income elasticity. As shown in Table 3.1, Korea 0.15the point estimate of the short-term price elasticityfor the Non-OECD group is much lower than forOECD countries—though not as precisely esti- Taiwan Province of China 0.10mated. Short-term income elasticity is only slightlyhigher than for OECD countries; however, long-term income elasticity is significantly higher for 0.05emerging market economies, at 0.39. Nevertheless, Chinathis value is substantially below the one found for 0.00energy, which is almost 1, and the weighted average 0 0.1 0.2 0.3 0.4of the two groups gives a combined elasticity of only PPP-weighted per capita GDP10.29. These results suggest that, instead of econo-mies becoming more energy efficient, oil intensity Sources: IMF, International Financial Statistics; International Energy Agency; World Bank,has been declining substantially, even in emerging World Development Indicators; and IMF staff calculations. 1 PPP = purchasing power parity.market economies—most probably as a result of thegrowing importance of other energy sources. The surprisingly low price responsiveness of oilconsumption in the OECD countries may reflectthe lack of large-scale shifts in fuel use since theearly 1990s. Most OECD countries saw a big switchaway from oil in electric power generation in theearly 1980s. After oil prices rose sharply compared 12In fact, the share of oil in total primary energy consumptionhas been decreasing since 1980, from 46 percent of the total in1980 to 34 percent in 2009. International Monetary Fund | April 2011 95

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERY with the prices of other fossil fuels in the 1970s, the power sector switched from oil to other inputs (Figure 3.6): some countries went back to coal (for example, the United States); others increased their nuclear capacity (for example, France) or turned to alternative energy sources. In fact, when the sample period is extended to the 1960s, the estimated price elasticities are higher (see Appendix 3.2). Today, however, the power sector is no longer an important Figure 3.5. Oil Consumption in China and in Selected oil consumer in OECD or emerging market econo- Advanced Economies mies. In fact, the transportation sector currently Per capita oil consumption in the United States and other OECD1 economies has accounts for about 50 percent of total oil consump- been broadly flat since the 1980s, while it has risen rapidly in China. tion.13 A substantial part of the remainder goes to the petrochemical industry and for other miscel- Per Capita Oil Consumption 0.09 (barrels a day) 0.007 laneous uses outside the power sector. Given current 0.08 United States 0.006 technologies, it is harder to substitute other factors (left scale) 0.07 for oil in these sectors, explaining the break in the 0.005 0.06 China estimated elasticities. (right scale) 0.004 0.05 OECD excluding United States1 Even though there has not been any substantial 0.04 (left scale) 0.003 substitution away from oil in recent years, new 0.03 0.002 backstop technologies are emerging in the trans- 0.02 0.001 portation sector. Predicting the scope for substitu- 0.01 tion using these technologies in the coming years is 0.00 0.000 1965 75 85 95 2005 09 difficult, but a big switch cannot be ruled out over the medium term. Addressing logistical problems Share of Global Oil Consumption 50 (percent) will pose a formidable challenge, but there should OECD excluding United States1 40 be a threshold at which alternative options become economically viable if oil prices are sustained above a 30 particular level.14 A mitigating factor in this respect United States is that in emerging market economies, a good part 20 13This includes jet fuel for aviation, bunker fuel as a naval 10 propellant, and diesel fuel (used in trucks, industrial machinery, China and cars). 0 14A simple calculation can give some insight regarding the 1965 75 85 95 2005 09 price threshold. Assume that the current cost premium for a plug-in electric car is $2,000, amortized on an annual basis. Sources: BP, Statistical Review of World Energy, June 2010; World Bank, World Furthermore, assuming a driver values mileage limitations and Development Indicators; and IMF staff calculations. 1 OECD = Organization for Economic Cooperation and Development. other logistical problems specific to electric cars at $1,000 a year and summing up the costs, we have a total premium of $3,000 over gas-engine cars. The next step is to calculate the breakeven point, which is found when the difference in operating costs of an electric car versus a gas-engine car is equal to the premium. U.S. average fuel consumption per vehicle was about 600 gallons in 2008 (see Federal Highway Administration, 2008, Table VM-1), while the retail gasoline price is roughly 0.035 times the imported oil price plus taxes. If we set the retail price of electricity for cars at 20 percent of the 2008 gasoline price, we get a backstop price for imported oil in the United States at about $155. Other important factors could affect our back-of-the-envelope calculations—for example, on the downside, increasing marginal costs of ramping up production that starts at a very low level or, on96 International Monetary Fund | April 2011

CHAPTER 3 OIL SCARCITY, GROWTH, AND GLOBAL IMBALANCES Table 3.1. Oil Demand Price and Income Elasticities (Subsample, 1990–2009) Short-Term Elasticity Long-Term Elasticity Price Income Price Income Combined OECD1 and Non-OECD –0.019 0.685 –0.072 0.294 [–0.028, –0.009] [0.562, 0.808] [–0.113, –0.032] [0.128, 0.452] OECD –0.025 0.671 –0.093 0.243 [–0.035, –0.015] [0.548, 0.793] [–0.128, –0.057] [0.092, 0.383] Non-OECD –0.007 0.711 –0.035 0.385 [–0.016, 0.002] [0.586, 0.836] [–0.087, 0.013] [0.193, 0.577] Source: IMF staff calculations. Note: Median elasticities and confidence intervals showing 10th and 90th percentile of the distribution in brackets are estimated by Monte Carlo simulations. Long-termelasticities are calculated using a 20-year horizon. 1OECD = Organization for Economic Cooperation and Development.of the infrastructure and distribution system is still Maturing is part of the normal life cycle of oilunder development and so, unlike in advanced fields (Box 3.1). What is novel since the late 1990seconomies, there will be less need to delay adoption is that such maturing started to affect the supplyof new technologies until current equipment and from major producing countries, beginning withinfrastructure become obsolete. Hence, it is conceiv- the North Sea fields. The resulting constraints onable that the (currently low) price responsiveness of non-OPEC production became evident in the earlyoil demand could increase again, not only in OECD 2000s, when oil demand began to grow unexpect-economies but also in emerging and developing edly and OPEC’s spare capacity declined.economies. The key question for the future is how the larger and likely growing number of maturing oil fieldsWhat are the prospects for oil supply? will affect the global oil supply outlook. In particu- Prospects for oil supply are strongly dependent lar, is the broad stagnation in oil production over theon production constraints in some major producing past five years temporary or more permanent? Theeconomies stemming from their oil fields reaching answer depends on how permanently the declinematurity—the stage when field production plateaus in production from maturing fields can be moreor declines. These constraints became obvious when than offset by increased production from newlyglobal crude oil production stagnated broadly during discovered reservoirs, from known but undevelopedthe global economic boom in the mid-2000s (Figure reservoirs, or from increased recovery from current3.7, top left panel).15 Most maturity-related declines fields, including the maturing ones (see IEA, Worldhave emerged in economies that are not members of Energy Outlook, 2008). Realizing such an offset willthe Organization of Petroleum Exporting Countries require continued large-scale investment, which the(OPEC), including Russia, but some OPEC pro- experience of the past five years has shown to be aducers reportedly also face challenges from mature formidable challenge.fields, including Saudi Arabia (Figure 3.7, top right Information to date suggests that the challengepanel).16 does not stem from a lack of desire to invest but rather from the lag between investment planning and delivery. Following sustained price increases,the upside, technological improvements and increasing returns to oil investment activity predictably turned around,scale in the production of electric cars. 15Although market outcomes reflect both demand and supply partly involving the development of higher-cost oildevelopments, it would be difficult to attribute the stagnation from ultra-deep water or unconventional resources.entirely to factors other than new supply constraints, given the Drilling activity—an integral part of explorationcombination of rising prices and positive, albeit small, supply and development in the oil sector—rose noticeablyprice elasticities as well as information about other factors (forexample, conflict-related disruptions). See Hamilton (2009). over the past decade (Figure 3.7, bottom left panel). 16See, for example, Sorrell and others (2010). Similarly, Goldman Sachs (2010) estimates that International Monetary Fund | April 2011 97

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERY peak production from the oil projects in its Top 280 energy projects will amount to about 28 million barrels a day in 2020.17 If the projects are executed and completed, these amounts could more than offset the decline from fields currently in operation, up to an aggregate decline rate of about 5 percent (the current production-weighted decline rate is estimated at about 4 to 4½ percent). Despite the increased investment activity, however, improvements in delivery have been slow. As noted, time-to-build lags can be 10 years or longer in the mining and oil industries, depending on theFigure 3.6. The Big Switch: Oil Share in the Electric complexity of the project. The turnaround in oilPower Sector 1 investment during the early 2000s therefore did not(Percent of total electricity production on y-axis) result in immediate capacity improvements, while the decline in oil investment from the mid-1980s to After oil prices rose sharply relative to those of other fossil fuels in the 1970s, the power sector in most Organization for Economic Cooperation and Development the late 1990s still had legacy effects. The latter will countries switched away from oil for power generation in early 1980s. dissipate only slowly, as some of the new projects started over the past few years will not increase 25 capacity for another 5 to 10 years. Investment delivery has also been hampered 20 by a surge in investment costs and by unexpected bottlenecks in oil investment services. As shown in the bottom right panel of Figure 3.7, one indica- 15 tor of investment cost—the U.S. producer price index for oil and gas well drilling—almost tripled between 2003 and 2005, suggesting relatively weaker 10 investment incentives. Higher cost and bottleneck problems, in turn, led investors to take a wait-and- see approach, and project approvals declined during 5 2007–08. Investment costs declined after the Great Recession but are still much higher in real terms. Similarly, bottlenecks in oil investment services have 01960 70 80 90 2000 09 become less severe. But they are still present and will likely unwind only gradually. Sources: International Energy Agency; and IMF staff calculations. 1Electricity generated by oil divided by total electricity production. Capacity increases are also constrained by restrictions on oil investment other than those related to pollution or other environment-related externalities, which have limited the overall investment response to high prices.18 First, many areas are essentially closed to participation by outside investors and are developed exclusively by national oil companies. 17According to estimates by Goldman Sachs (2010), all projects achieve positive net present values with oil prices above $80 a barrel (in constant U.S. dollars). 18See Box 1.5 in the April 2008 World Economic Outlook for a detailed discussion.98 International Monetary Fund | April 2011

CHAPTER 3 OIL SCARCITY, GROWTH, AND GLOBAL IMBALANCESWhile some national oil companies have ramped upcapital expenditure in response to higher prices, oth-ers have been constrained by short-term budgetaryrevenue considerations. The lack of outside par-ticipation may also prevent the necessary upgradesin technology for exploration and development. Figure 3.7. Global Oil Market DevelopmentsSecond, rising oil prices have also prompted changesin the regulatory environment, especially with Global crude oil production stagnated broadly during the global economic boom in therespect to taxation and ownership, which have raised mid-2000s, notably in countries that are not members of the Organization ofcosts or reduced profitability and thereby slowed Petroleum Exporting Countries. The lag between investment planning and delivery seems to be the challenge in the medium term.investment. Against this backdrop, net capacity will likely World Oil Production1 Oil Production by Major Groups2build only gradually. A return to the trend growth 90 (million barrels a day) (million barrels a day) 40of 1.8 percent in oil production experienced during 801981–2005 seems unlikely at this point despite the 30current investment effort, given continued field 70 Previous peak Stagnation (1979)declines in some major producers.19 In other words, 60 FSU 20prospects are for a downshift in the trend growth Non-OPEC excluding FSU 50 OPECrate of oil supply. Current medium-term forecasts by 10the International Energy Agency (IEA, 2010a and 40 Previous peak (1988)2010b), for example, suggest only modest increases 30 0in new net capacity over the next five years (Figure 1965 75 85 95 2005 10 1991 96 2001 06 103.8). Because capacity increases are the main drivers International Rotary Rig Count, by United States PPI for Oil and Gasof supply growth—the short-term price elasticity Region Drilling and Price of WTI3of supply is very low, with most estimates ranging (level) (December 1985 = 100)between 0.01 and 0.1—supply increases will likely Africa East Asia Europe Middle Eastbe equally modest, except for the buffer provided Latin America United States 6000 + Canada 600by OPEC spare capacity.20 The latter is currently WTIestimated at some 6 million barrels a day. Assum- 5000 500ing that between two-thirds and four-fifths of that 4000 400spare capacity will eventually be tapped, cumulativeoil supply growth during 2011–15 could amount 3000 300to 6 to 8 percent, or 1¼ to 1½ percent annually on 2000 PPI 200average, if the price of oil remains broadly constant 1000 100in real terms.21 It is likely that part of the downshift in the oil 0 1975 85 95 2005 10 1985 90 95 2000 05 0 Nov.supply trend has already been factored into current 10oil pricing. Nevertheless, predictions of the extent Sources: Bakker Hughes; BP, Statistical Review of World Energy; and Haver Analytics. 1 Piecewise linear trend. 2 19We exclude from the calculation all periods of turbulence in FSU = former Soviet Union; OPEC = Organization of Petroleum Exporting Countries. 3 PPI = producer price index; WTI = West Texas Intermediate.world oil markets, such as the early 1980s, and we also excludethe post-2005 period, which, as shown in Hamilton (2009),already exhibited a below-trend output growth rate. A downshiftwould also be consistent with the investment oil prediction fromGoldman Sachs’s Top 280 energy project inventory noted earlier. 20See, for example, Dées and others (2007) for recent estimatesof supply elasticities. 21This assumes that OPEC keeps a spare capacity buffer of 2million barrels a day, which is in line with its stated intentions. International Monetary Fund | April 2011 99

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERY and speed of capacity buildup are usually charac- terized by a high amount of uncertainty. Indeed, project delivery was typically overestimated over the past few years, and some of the underlying risk factors are still present. Such risk factors include uncertainty about time- to-build lags, potentially rising investment costs if the global economy continues on a brisk expansion, and risks to investment regimes. In addition, there is considerable uncertainty about the future paths of decline rates in maturing ﬁelds (see Box 3.1). Finally,Figure 3.8. Projected Growth in Crude Oil Capacity geopolitical risks, both short- and long-term, remain,(Million barrels a day) and changes in oil scarcity could be accompanied by changes in the market shares of large producers. Despite the current investment effort, new net capacity in oil production will Therefore, there is a risk of larger-than-anticipated increase only modestly in the medium term given continued field declines in some oil scarcity. The possibilities range from larger major producers. downshifts in trend supply growth to an outright 2.0 decline in oil production, either temporarily or more Former Soviet Union (FSU) Non-OPEC excluding FSU OPEC 1 Total permanently.22 1.5 What Are the Implications for Oil Scarcity? The main reason behind continued, if not 1.0 increased, oil scarcity is the tension between, on the one hand, the downshift in oil supply trends by some ¼ to ½ percent, with further downside risk, 0.5 and, on the other hand, the strong momentum in oil demand growth stemming mainly from rapid income growth in emerging market economies. 0.0 The current WEO forecast is for an annual average world GDP growth rate of about 4.6 percent -0.5 over the period 2011–15. The extent of market 2010 11 12 13 14 15 tension generated by these rates of global growth will depend on the income elasticity of oil demand. Sources: International Energy Agency, Medium-Term Oil Market Report, June 2010 and December 2010 update. If a global short-term income elasticity of 0.68 (as 1 Including spare capacity; OPEC = Organization of Petroleum Exporting Countries. estimated in the previous section) held throughout 2011–15, oil demand growth would remain above the growth in production at unchanged prices. Because price elasticities are very small, only substantial price increases would succeed in balancing the market, as described in the following example. At unchanged prices, if oil supply grows by 1.5 percent, 22For example, recent medium-term production forecasts by the U.S. EIA suggest annual oil production capacity growth of 0.9 percent over the period 2011–15. Other medium-term scenarios predicting low if any trend growth in oil production include British Petroleum (2011) and Shell (2011).100 International Monetary Fund | April 2011

CHAPTER 3 OIL SCARCITY, GROWTH, AND GLOBAL IMBALANCESthen oil demand growth will exceed that of supply changes, and macrofinancial linkages in the form ofby about 1.5 percentage points (4.6 × 0.68 – 1.5). a financial accelerator. The version used here has sixWith demand price elasticity at –0.02 and no supply economic regions—oil exporters, the United States,response, the oil price should increase by 75 percent the euro area, Japan, emerging Asia, and remainingto rebalance the oil market. countries. All regions are assumed to have flexible The assumption of a zero supply response is exchange rates.clearly unrealistic. Moreover, as discussed earlier, The main simulation considers the effects of athere is strong evidence that longer-term income downshift in the trend growth rate of world oilelasticities are lower than short-term ones.23 The ten- output in a controlled setting (Figure 3.9).25 Thesion between moderate supply growth and continued motivation for the experiment follows from thehigh global economic growth could thus be resolved analysis of oil demand and supply prospects in thewith smaller and, most likely, more gradual oil price previous sections. Because these prospects are subjectincreases, with some accompanying demand modera- to a great deal of uncertainty, the simulations assumetion. Nevertheless, with important downside risks to that economic actors are surprised when the oilsupply, oil scarcity risks will remain. growth rate starts to decline.26 This section also con- Oil scarcity risks must also be considered in the siders three sets of scenarios to examine the impactcontext of the overall energy market. If the supply of changes in significant parameters.of other primary energy sources continues to growfaster than the supply of oil, the past pattern ofrelatively slower oil demand growth in an environ- What Is the Model and How Is It Calibrated?ment of rapid GDP growth could be sustained. As To understand the global economic impact of oilof now, the situation seems promising. In particular, scarcity, we need to look at a few aspects of the modelthe so-called shale gas revolution may become a setup. The main difference between this applicationgame changer and lay the foundation for a more and the standard version of the GIMF is that oil is aglobal market for natural gas (Box 3.2). Natural gas third factor in an economy’s production, in addi-could also become viable for applications that have tion to capital and labor, and a second factor in finalso far relied almost exclusively on oil, including consumption, in addition to goods and services. Thetransportation. price and availability of oil therefore influence production as well as consumption possibilities. The price responsiveness of oil demand, whichOil Scarcity and the Global Economy reflects the degree to which other inputs can substi- To assess the implications of greater oil scarcity tute for oil, is an important parameter determiningfor global economic growth and current account the impact of changes in oil market conditions.imbalances, this section uses simulation analysis In the benchmark simulation, the long-term pricebased on the IMF’s Global Integrated Monetary elasticity of oil demand in both production andand Fiscal Model (GIMF), a multiregion dynamic consumption is assumed to equal 0.08, while thegeneral equilibrium model.24 The GIMF includes short-term elasticity is about 0.02. This is consistentseveral features found to be important for replicat- with the estimates for the 1990–2009 sample in theing real-world behavior, including households’ and previous section.firms’ finite planning horizons, gradual adjust-ment of prices and nominal wages to unexpected 25Figure 3.9 also has a full listing of the countries included in each group. 23In the present discussion of oil demand, the combined 26Actors are assumed to acquire full and immediate knowl-income elasticity is 0.29 over a 20-year horizon. edge about the extent of the change in oil scarcity. In practice, 24For a presentation of the structure of the GIMF, see Kumhof, information may be incomplete, and economic actors may learnMuir, and Mursula (2010). For applications, see Kumhof and only over time about the full extent of resource scarcity. The mainLaxton (2007, 2009), Freedman and others (2010), and Clinton effect of this delayed acquisition of knowledge would be smallerand others (2010). initial effects, but qualitatively the results remain broadly similar. International Monetary Fund | April 2011 101

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERYFigure 3.9. Oil Scarcity and the Global Economy: Benchmark Scenario(Years on x-axis)This scenario considers the effects of a downshift in the trend growth rate of world oil output by 1 percentage point each year and the eventual return to the initial growthrate in year 25. World1 Oil Exporters2 United States Emerging Asia3 Euro Area4 Japan Real GDP Real GDP (percent difference) (percent difference)1 1 1 2 1 10 0 0 0 0 0-1 -1 -1 -1 -1 -2-2 -2 -2 -2 -2-3 -3 -3 -4 -3 -3-4 -4 -4 -6 -4 -4 0 5 10 15 20 0 5 10 15 20 0 5 10 15 20 0 5 10 15 20 0 5 10 15 20 0 5 10 15 20 Real Interest Rate (percentage point Real Absorption (percent difference) difference)0.2 35 2 5 2 50.0 28 0 0 0 0-0.2 -2 21 -2 -5-0.4 -4 -5 14 -4 -10-0.6 -6 7 -6 -15 -10-0.8 -8-1.0 0 -8 -20 -10 -15 0 5 10 15 20 0 5 10 15 20 0 5 10 15 20 0 5 10 15 20 0 5 10 15 20 0 5 10 15 20 Oil Supply Current Account (percent of GDP; difference) (percent difference) 5 10 0.5 1.0 0.5 1.0 0.5 0.5 0 8 0.0 0.0 0.0 0.0 -5 6 -0.5 -0.5 -0.5 -0.5-10 4 -1.0 -1.0 -1.0 -1.0 -1.5-15 2 -1.5 -1.5 -1.5 -2.0-20 0 -2.0 -2.0 -2.0 -2.5 0 5 10 15 20 0 5 10 15 20 0 5 10 15 20 0 5 10 15 20 0 5 10 15 20 0 5 10 15 20 Oil Price Net Oil Exports (percent of GDP; difference) (percent difference)200 20 1 2 1 2 0 0150 15 0 0 -2 -1 -1 -2 -2100 10 -4 -2 -3 -4 -6 -4 50 5 -3 -6 -8 -5 0 0 -4 -10 -6 -8 0 5 10 15 20 0 5 10 15 20 0 5 10 15 20 0 5 10 15 20 0 5 10 15 20 0 5 10 15 20 Source: Global Integrated Monetary and Fiscal Model. 1World: Total of all countries accounts for 78.78 percent of world GDP. 2Oil Exporters: Algeria, Angola, Azerbaijan, Bahrain, Canada, Republic of Congo, Equatorial Guinea, Iraq, Kuwait, Libya, Mexico, Nigeria, Norway, Oman, Qatar, Russia, Saudi Arabia,United Arab Emirates, and Venezuela. 3Emerging Asia: China, Hong Kong SAR, India, Indonesia, Korea, Malaysia, Philippines, Singapore, and Thailand. 4Euro area: Austria, Belgium, Cyprus, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, Netherlands, Portugal, Slovak Republic, Slovenia, and Spain. 102 International Monetary Fund | April 2011

CHAPTER 3 OIL SCARCITY, GROWTH, AND GLOBAL IMBALANCES Another important parameter is the contribution How Will Lower Oil Supply Trends Affect the Globalof oil to output, which in the benchmark will be Economy?determined by the oil cost share. Based on recent The benchmark simulation analyzes the impacthistorical data, it has been calibrated at 2 to 5 per- of a decline in the average growth rate of world oilcent, depending on the sector and region. production by 1 percentage point below its historical The supply side of oil has several elements. First, trend starting in year 1 and an eventual return to itsthere is an exogenous endowment of oil. The growth initial growth rate in year 25. Figure 3.9 shows thein that endowment is assumed to fall below historical impact on a number of variables, expressed as devia-trends. This represents the constraints from matur- tions in percentage points (or percent) from a situ-ing fields on global oil supply discussed earlier. The ation in which oil production grows at its historicalsecond element is a positive supply response to higher trend rate of 1.8 percent.oil prices, but with a low price elasticity of 0.03. The Beginning with the global impact, the unexpectedthird element is extraction cost. Here we assume that, persistent reduction in oil supply growth leads to aninitially, 40 percent of oil revenue must be used to immediate oil price spike of some 60 percent. Thispay for intermediate goods inputs; thereafter, the real reflects the very low short-term oil demand elastic-extraction cost per barrel of oil increases at a constant ity. Because the decline in supply is persistent, theannual rate of 2 percent.27 real oil price continues to increase thereafter, because An important element in tracing the effects of market equilibrium requires some “demand destruc-oil scarcity is the use of the oil rent, the difference tion.” Over a 20-year horizon, the cumulative oilbetween the market price and extraction costs. This price increase amounts to about 200 percent.rent is distributed between the domestic private The reduced availability of oil and the resultingsector and the government. In advanced economies, higher oil prices lead to a reduction in GDP levelsthe government is assumed to receive only a very in oil importers in the longer term. In the shortsmall portion of these receipts, while in oil exporters to medium term, however, the global adjustmentit receives 90 percent. Critically, it is assumed that is shaped by the wealth transfer from oil import-the government does not spend the additional funds ers to oil exporters, which has large effects onimmediately but accumulates them in a U.S.-dollar- trade and capital flows. With rising oil prices, oilbased fund that is spent at a rate of 3 percent a year. exporters experience sustained increases in incomeOne of the key effects of an increase in the oil price, and wealth. As a result, their domestic demandtherefore, is a dramatic increase in world savings due (domestic absorption) increases ahead of GDP atto governments’ low propensity to consume out of more than 1.5 percent annually. The higher spend-oil revenues. ing leads to upward domestic price pressures and Finally, although the GIMF is well suited to a large real appreciation of the domestic currency.medium- and long-term analysis, some complex This reduces output in the tradables sector (otherfactors that are not part of the model (for example, than oil), thereby reducing GDP by more thanthe nature of the oil shock, its transmission through 3 percent over the first five years, followed by afinancial markets, confidence effects) may be at play recovery as government spending starts to consumein the short term that amplify the initial output a share of the growing oil fund. The current accountresponse to an oil scarcity shock. Box 3.3 explains improvement in this group of economies, whichin greater detail the nature of the problem and the equals about 6 percent of GDP in the short termmost relevant amplification channels highlighted in and more than 10 percent after 20 years, is duethe literature. entirely to the higher value of oil exports. Goods exports fall relative to GDP, and the non-oil current 27Together, the second and third elements mimic the possibility account deteriorates. But the government’s very lowof replacing crude oil from conventional sources with oil fromhigher-cost unconventional sources (see, for example, IEA, World propensity to consume out of the oil fund meansEnergy Outlook, 2008, p. 218). that the size of that deterioration remains moderate. International Monetary Fund | April 2011 103

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERY Domestic absorption by oil importers contracts over tion and consumption. For oil exporters, the initial time as a result of lower oil availability, by 0.35 to real output loss due to lower oil production is also 0.75 percent a year depending on the region. Their amplified by the deterioration of the non-oil trade GDP also declines, but they initially experience two balance due to appreciation in the real exchange countervailing effects that support output. The first, value of the currency. and more important, is a surge in goods exports to oil importers to satisfy their increasing domestic demand. The second is a surge in investment Alternative Scenarios demand in response to lower world real interest This section explores the sensitivity of the bench- rates. This is because the oil exporters’ additional oil mark results to three of the underlying assump- revenue, which accrues primarily to governments, tions—namely, the role played by oil’s price elasticity leads to higher saving, which reduces world real of demand, the effect of a more sizable shock to oil interest rates by almost 100 basis points over 20 supply trends, and the importance of oil for aggre- years.28 This effect is reminiscent of the international gate production. In the accompanying figures, the lending boom in the 1970s and early 1980s follow- benchmark simulation results are shown as a solid ing large oil price increases. Regional differences blue line, and each alternative scenario is shown as a among oil importers in this phase of the adjustment dashed red line. stem mostly from differences in the strength of their export links with oil exporters, with GDP in Scenario 1: greater substitution away from oil emerging Asia and Japan benefiting the most from A first alternative scenario considers a higher value the consumption boom in that region. In addition, for the long-term price elasticity of demand, consis- emerging Asia also benefits more from lower world tent with greater substitution away from oil during real interest rates, in view of the region’s higher pro- periods of high oil prices. The scenario is based on a pensity to invest. Global imbalances worsen in this higher, more optimistic long-term elasticity of 0.3, scenario over the short to medium term. The United almost five times as high as that used in the bench- States and euro area current accounts deteriorate as a mark scenario. The feasibility of greater substitution result of costlier oil imports, while during a lengthy is subject to uncertainty because it is difficult to transition period the current accounts of surplus predict the path of the technological developments regions improve (emerging Asia), or remain nearly required to bring it about.29 unchanged (Japan), as they export more goods to This alternative scenario has world oil prices oil exporters. The long-term effects are not particu- increasing by only 100 percent after 20 years, rather larly large, however: oil importers’ current accounts than 200 percent as in the benchmark scenario deteriorate by 1.5 to 2 percentage points of GDP by (Figure 3.10). This reduces the drop in world output year 20. This is explained by oil’s relatively low share by two-thirds and by even more in oil importers. in aggregate costs. The longer-term current account developments are In the benchmark simulation, the longer-term also much more favorable, mainly because easier output effects are not very severe. For oil import- substitution away from oil allows importers to keep ers, output falls cumulatively by between 3 percent the net oil import balance in check. This simulation (Japan, euro area) and 5 percent (emerging Asia) highlights the fact that fairly high demand elasticities after 20 years, corresponding to about 0.15 to 0.25 would be required to negate the effects of lower oil percent a year, compared with a situation in which availability. oil production follows past trends. The regional differences in the size of the long-term output effects reflect differences in the shares of oil in produc- 29Hirsch, Bezdek, and Wendling (2005, 2010), for example, 28They start to increase again soon after the 20-year horizon, examine alternative fuels and technologies and conclude that as the government spends more and more of its accumulated oil substitution away from oil on a large scale would be extremely funds. expensive and time-consuming. See also Ayres (2007).104 International Monetary Fund | April 2011

CHAPTER 3 OIL SCARCITY, GROWTH, AND GLOBAL IMBALANCESFigure 3.10. Alternative Scenario 1: Greater Substitution away from Oil(Years on x-axis)This scenario considers a higher value for the price elasticity of demand (0.3, compared with 0.08 in the baseline scenario), consistent with greater substitution awayfrom oil. Benchmark scenario Upside scenario World Oil Exporters United States Emerging Asia Euro Area Japan Real GDP Real GDP (percent difference) (percent difference)1 1 1 2 1 10 0 0 0 0 0 -1-1 -1 -2 -1 -1 -2-2 -2 -4 -2 -2 -3-3 -3 -4 -6 -3 -3-4 -4 -5 -8 -4 -4 0 5 10 15 20 0 5 10 15 20 0 5 10 15 20 0 5 10 15 20 0 5 10 15 20 0 5 10 15 20 Real Interest Rate (percentage point Real Absorption (percent difference) difference)0.2 30 2 5 2 50.0 0 0 0 0-0.2 20 -2 -2 -5-0.4 -4 -5 -4 -10-0.6 10 -6 -6 -15 -10-0.8 -8-1.0 0 -8 -20 -10 -15 0 5 10 15 20 0 5 10 15 20 0 5 10 15 20 0 5 10 15 20 0 5 10 15 20 0 5 10 15 20 Oil Supply Current Account (percent of GDP; difference) (percent difference) 5 10 0.5 1.5 0.5 1 0 8 1.0 0.0 0.0 0.5 0 -5 6 -0.5 -0.5 0.0-10 4 -1.0 -0.5 -1-15 -1.0 2 -1.0 -1.5-20 0 -1.5 -1.5 -2.0 -2 0 5 10 15 20 0 5 10 15 20 0 5 10 15 20 0 5 10 15 20 0 5 10 15 20 0 5 10 15 20 Oil Price Net Oil Exports (percent of GDP; difference) (percent difference)200 20 1 2 1 2 0 0 0 0150 15 -2 -1 -1 -2100 10 -4 -2 -2 -4 -6 -3 50 5 -3 -6 -8 -4 0 0 -4 -10 -5 -8 0 5 10 15 20 0 5 10 15 20 0 5 10 15 20 0 5 10 15 20 0 5 10 15 20 0 5 10 15 20 Source: Global Integrated Monetary and Fiscal Model. Note: For the list of countries in each group, see Figure 3.9. International Monetary Fund | April 2011 105

WORLD ECONOMIC OUTLOOK: TENSIONS FROM THE TWO-SPEED RECOVERY Scenario 2: greater declines in oil production channels that amplify the effects of oil shocks.32 To Another alternative scenario considers the explore the implications of a potentially larger con- implications of a more pessimistic assumption tribution by oil to output, the third alternative sce- for the declines in world oil output—3.8 percent nario assumes that part of total factor productivity rather than 1 percent annually—accompanied by represents technologies that are possible and remain a 4 percent annual increase in real extraction costs usable only when there is a ready supply of oil. This per barrel rather than 2 percent (Figure 3.11). This effect is assumed to be external so that the beneficial implies that, barring any increase due to the supply effects of oil are not captured exclusively by the sup- response to higher prices, oil production declines pliers of oil but rather by all factors of production in by 2 percent annually—a scenario that reflects the proportion to their cost-share coefficients. The impli- concerns of peak oil proponents, who argue that cation is that a negative oil supply shock resembles a oil supplies have already peaked and will decline negative technology shock.33 rapidly.30 In this scenario, the longer-term output Figure 3.12 compares the benchmark scenario to and current account effects are roughly three to four a downside one in which the contribution of oil to times as large as in the benchmark scenario, meaning output (either directly or as an enabler of technol- they increase roughly in proportion to the size of the ogy) amounts to 25 percent in the tradables sector shock.

WORLD ECONOMIC OUTLOOK

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