The rest of the world is ratcheting up already intense pressure on Washington and Brussels to head off another global economic crisis, as the outlook grows ever dimmer.
The gravest threats to the increasingly fragile recovery lie in a divided United States and a wounded euro zone, according to the growing chorus of voices that are urging governments to act quickly and decisively to deal with crippling debt and fiscal problems.
The unspooling euro zone debt crisis, the rapid decline of economies across the region and the pervasive weakness of the banking system have been a focus of worry among policy makers for some time. The fears about Washington centre on the widespread fallout from the impending "fiscal cliff" on Jan. 1, when a raft of tax breaks expires and hefty spending cuts and tax increases take effect unless warring Democrats and Republicans can reach a compromise.
Calling the risks of a worldwide slump "alarmingly high" as it warned of decelerating economies, the IMF puts the odds of global growth falling below 2 per cent – effectively a recession – at one-in-six.
At that rate of growth, the global economy is too weak to keep up with population growth.
"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," the IMF said in its World Economic Outlook released in advance of the annual World Bank-IMF meeting in Tokyo.
For Canada, the agency warned of the dangers posed by a weaker housing market and high consumer debt levels and cited Canada's close economic and financial ties to the U.S. economyas a risk. It cut its Canadian growth forecast for this year and next by 0.2 of a percentage point in each – to 1.9 per cent and 2 per cent, respectively, with unemployment stable but high at 7.3 per cent.
The IMF sliced its global growth forecast to 3.3 per cent this year from 3.5 per cent in its previous reading in July, which would mark the slowest expansion since 2009, when the world was emerging from the deepest slump since the Great Depression.
The influential agency has also reduced its projected growth in 2013 to 3.6 per cent from 3.9 per cent just three months ago and 4.1 per cent in April. But it warned ominously that even the lower projection for 2012 and beyond "depends on whether European and U.S. policy makers deal pro-actively with their major short-term economic challenges."
The IMF predicts GDP for the 17-country euro zone will contract by 0.4 per cent this year and post minimal growth of 0.2 per cent in 2013. Its forecast for the U.S. economy calls for expansion of 2.2 per cent this year and 2.1 per cent next year, in line with the consensus.
The IMF report makes for sober reading. But it only underscores what the data have been signalling about key economiesfor some time. All are slowing, several have slipped back into recession, others are treading water or sinking, and current policies are doing little to reverse the tide. Indeed, the austerity drive in Europe and the fiscal impasse in the U.S. are making matters considerably worse.
"The recovery has suffered new setbacks, and uncertainty weighs heavily on the outlook," IMF chief economist Olivier Blanchard notes. "A key reason is that policies in the major advanced economies have not rebuilt confidence in medium-term prospects. Tail risks, such as those relating to the viability of the euro area or major U.S. fiscal policy mistakes, continue to preoccupy investors."
The advanced economy woes, in turn, "are affecting emerging market and developing economies through both trade and financial channels, adding to homegrown weaknesses," Mr. Blanchard said in a statement.
Fuelling further fears of a global retrenchment are signs that China is headed for slower growth, which has led the central bank into another round of pump-priming. Mining giant Rio Tinto PLC also said Tuesday that it is unlikely to proceed with any new high-cost projects in light of a larger-than-expected economic slowdown in China and falling commodity demand. Along with Australian rival BHP Billiton Ltd., the company said it is now concentrating on slashing costs.
But a more optimistic scenario could play out if U.S. politicians back away from the fiscal cliff, and if the Europeans corral their debt crisis, fix their broken banks, stabilize the battered peripheral economies and restore confidence in the single currency.
"The general strategy is clear. Continue with accommodating monetary policy … and limit the adverse effects of the brakes holding things back. Continue with steady fiscal consolidation," said IMF chief economist Olivier Blanchard.
But fiscal consolidation is just econo-speak for austerity, which Paul Krugman and several other prominent economists argue is only making a bad situation worse by increasing unemployment and welfare rolls and slashing government revenues. Advocates argue that the benefits outweigh the risks; as the cost of capital falls, business confidence improves and companies become more cost competitive.
Still, prolonged weakness is likely to remain a feature of the global outlook.
"Mr. Economy now has a serious chronic condition with limited prospects of a full cure," said Satyajit Das, an Australian-based risk expert. "He might continue to live but in an impaired state of no or low growth for a prolonged period. The threat of a sudden life-threatening seizure cannot be discounted."
From the International Monetary Fund's world economic outlook
On the world economy
"Risks for a serious global slowdown are alarmingly high"
On Europe and the euro zone
"The recession in most of the periphery is increasingly spilling into other economies in the region … The possibility that the euro area crisis will escalate remains a major downside risk to growth and financial sector stability until the underlying issues are resolved."
Euro area 2012 GDP projection: -0.4% (-0.1%)
On the United States
"A modest recovery with weak job creation continues amid a weak global environment, though the housing market is stabilizing … The urgent policy priorities in the United States are to avoid excessive fiscal contraction in the short term, promptly raise the debt ceiling, and agree on a credible fiscal consolidation plan – centered around entitlement and tax reforms – that places government debt on a sustainable path in the medium term."
2012 GDP projection: 2.2% (-0.1%)
"Given its strong economic and financial ties with the U.S. economy, Canada is equally exposed to the risks facing its trading partner. In addition, an important domestic vulnerability in Canada relates to the housing market. A sharp or sustained decline in house prices could seriously set back the leveraged household sector and domestic demand."
2012 GDP projection: 1.9% (-0.2%)
"Growth in Asia has moderated further with weaker external demand the soft landing of domestic demand in China. The outlook is for a modest pickup in growth on the back of recent policy easing. Limited direct financial spillovers and some room for policy easing should be helpful in minimizing external downside risks."
China 2012 GDP projection: 7.8% (-0.2%)
On Latin America and the Caribbean
"Growth is expected to pick up later this year, as recent policy easing gains traction. Risks to the near-term growth outlook are to the downside, as elsewhere. With continued rapid credit growth and inflation above the midpoint of the target band in many economies in the region, however, the priority is to rebuild macroeconomic policy space unless downside risks materialize."
2012 GDP projection: 3.2% (-0.2%)