Prophecies of doom

"Slowing growth, rising risks" – this is the short but ominous phrase the International Monetary Fund (IMF) chose as the title of its latest World Economic Outlook study.

"The global economy has entered a dangerous new phase," IMF chief economist Olivier Blanchard said as he presented the report in Washington on Tuesday.

"The recovery has weakened considerably, and downside risks have increased sharply," he said, adding that politicians needed to step up and make tough economic decisions: "Strong policies are needed both to improve the outlook, and to reduce the risks."

The IMF said a number of factors have combined this year to exacerbate economic problems, including the earthquake in Japan, the debt crisis in the eurozone, and the United States' monstrous state deficit. According to the IMF, these dangerous developments are still threatening the world's economic recovery and undermining confidence.

The biggest problem? Europe

The IMF singled out the eurozone crisis as a matter of particular concern. If the contagion of ballooning public debt should spread from Europe's peripheral countries to larger economies such as Germany, world markets could wobble.

It's no surprise, then, that the IMF has downgraded its growth prognoses for both this year and the next. IMF experts expect the world economy will only grow by 4 percent in 2011 and 2012.

"Four percent doesn't sound too bad, but again, the recovery is very unbalanced," Blanchard said. "For 2011, we see growth of 6.4 percent for emerging market countries, which is a good number, but only 1.6 percent for advanced economies."

This disparity is a key concern of the IMF, and has prompted warnings that the world economy could fall into several vicious feedback loops if governments don't intervene quickly.

"Low growth and fiscal and financial weaknesses can easily feed on each other," Blanchard said. "Low growth makes fiscal consolidation harder, and fiscal consolidation may lead to lower growth. Low growth weakens banks, and weaker banks lead to tighter bank lending and lower growth. In short, there are clear downside risks to the forecasts."

Politicians need to bite the bullet

The IMF says that to escape these looming Catch-22 situations, national leaders need to base their policy on three pillars. First, a controlled reduction of public debt, whereby the budget cuts are not so deep as to endanger growth. Second, a reinforcement of the banking system, which needs to be supported with more equity. And third, a direct appeal to the US to reduce its massive budget and trade deficits.

China received special praise from the IMF because it is working to reduce its dependency on exports and develop demand in its domestic market. But, like all the other measures suggested by the IMF, sweeping changes won't happen overnight.

Author: Rolf Wenkel, Washington / bk
Editor: Sam Edmonds