The IMF cut its global growth forecast on Tuesday for the second time since April and warned U.S. and European policy makers that failure to fix their economic ills would prolong the slump.
Global growth is too weak to bring down unemployment and what little momentum exists is coming primarily from central banks, the International Monetary Fund said in its World Economic Outlook, released ahead of its twice-yearly meeting, which will be held in Tokyo later this week.
“A key issue is whether the global economy is just hitting another bout of turbulence in what was always expected to be a slow and bumpy recovery or whether the current slowdown has a more lasting component,” it said.
“The answer depends on whether European and U.S. policy makers deal pro-actively with their major short-term economic challenges.”
For 2012, the IMF now expects global output to grow just 3.3 per cent, down from its July estimate of 3.5 per cent, making it the slowest year of growth since 2009. It predicted only a modest pickup next year to 3.6 per cent, below its July estimate of 3.9 per cent.
Emerging markets are still expected to grow four times as fast as advanced economies, but the IMF took a sharp knife to its estimates for India and Brazil, with the latter now seen growing slower than the United States this year.
The IMF said “familiar” forces were dragging down advanced economy growth: fiscal consolidation and a still-weak financial system, the same problems that have plagued the world since the global financial crisis exploded in 2008.
“More seems to be at work, however, than these mechanical forces – namely, a general feeling of uncertainty,” IMF Chief Economist Olivier Blanchard said.
Measures of risk and uncertainty, such as the VIX volatility gauge in the United States, remain at low levels, Mr. Blanchard pointed out, which makes it difficult to assess the nature of the uncertainty. Blanchard described it as “more Knightian in nature,” referring to a term for risk that is impossible to measure, named after economist Frank Knight.
“Worries about the ability of European policy makers to control the euro crisis and worries about the failure to date of U.S. policy makers to agree on a fiscal plan surely play an important role, but one that is hard to nail down,” Mr. Blanchard said.
The IMF said financial conditions are likely to remain “very fragile” over the near term because repairing euro zone problems will take time and there are concerns about how the U.S. economy will cope with the expected expiry of tax cuts early next year.
For the United States, the IMF said its “urgent policy priorities” should include avoiding a so-called “fiscal cliff” from the expected tax increases and spending cuts, raising the government borrowing limit, and agreeing on a credible plan to reduce the deficit.
It said the fiscal cliff at the extreme would amount to a fiscal withdrawal of more than 4 per cent of GDP in 2013, and economic growth would stall.
In the euro area, it said resolving the crisis was the highest priority, and that would require progress toward banking and fiscal union.
“If uncertainty is indeed behind the current slowdown, and if the adoption and implementation of these measures decrease uncertainty, things may turn out better than our forecasts, not only in Europe, but also for the rest of the world,” Mr. Blanchard said. “I, for once, would be happy if our baseline forecasts turn out to be inaccurate – in this case, too pessimistic.”