World economic and financial surveys world economic outlook IMF housing and the business cycle apr 08

World Economic Outlook, April 2008
World Economic Outlook Housing and the Business Cycle
World Economic Outlook
Housing and the
Business Cycle
World Economic and Financial Surveys
INTERNATIONAL MONETARY FUND
08
APR
IMF
APR
08
WORLD ECONOMIC OUTLOOK
April 2008
Housing and the Business Cycle
International Monetary Fund
World Economic and Financial Surveys
©2008 International Monetary Fund

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iii
CONTENTS
Assumptions and Conventions viii
Preface x
Foreword xi
Executive Summary xiv
Chapter 1. Global Prospects and Policies 1
Overview of Recent Developments and Prospects: Divergence but Not Decoupling 1
Financial Market Turbulence: Rocky Ride for the Advanced Economies 4
Can Emerging and Developing Economies Decouple? 22
Outlook and Risks for the Global Economy 30
Policy Challenges in a Multipolar World 38
Appendix 1.1. Implications of New PPP Estimates for Measuring Global Growth 43
Appendix 1.2. Commodity Market Developments and Prospects 46
References 62

Chapter 2. Country and Regional Perspectives 65
United States and Canada: How Long Will the Slowdown Last? 65
Western Europe: Can a Sharp Slowdown Be Averted? 75
Advanced Asia: How Resilient Is Growth in Japan to a Global Slowdown? 78
Emerging Asia: Strong Internal Momentum, but Rising Risks from Spillovers 80
Latin America and the Caribbean: Facing a Cold North Wind 82
Emerging Europe: Adjusting to a Rougher External Environment 85
Commonwealth of Independent States: Containing Infl ation Remains the
Central Challenge 88
Sub-Saharan Africa: Strong Growth Prospects, but Risks Remain 94
Middle East: Infl ation Is a Growing Concern 97
References 99
Chapter 3. The Changing Housing Cycle and the Implications for Monetary Policy 103
Developments in Housing Finance 104
The Housing Sector and the Business Cycle 107
Housing Finance and Spillovers from Housing 110
Housing Finance and Housing as a Transmission Channel for Monetary Policy 117
Should Changes in the Housing Cycle Affect the Conduct of Monetary Policy? 122
Conclusions 126
Appendix 3.1. Data and Methodology 128
References 130
CONTENTS
iv
Chapter 4. Climate Change and the Global Economy 133
How Will Climate Change Affect Economies? 134
How Can Countries Best Adapt to Climate Change? 147
How Can Countries Effectively and Effi ciently Mitigate Climate Change? 155
Conclusions 173
Appendix 4.1. The G-Cubed Model, Baseline Assumptions, and Other Models in
the Climate Change Literature 175

References 184
Chapter 5. Globalization, Commodity Prices, and Developing Countries 191
Commodity Prices and Patterns of Integration 197
Globalization and Commodity Price Cycles 205
Explaining the Patterns 210
Conclusions 213
Appendix 5.1. Data and Methodology 215
References 220
Annex: IMF Executive Board Discussion of the Outlook, March 2008 223
Statistical Appendix 229
Assumptions 229
What’s New 232
Data and Conventions 232
Classifi cation of Countries 234
General Features and Composition of Groups in the World Economic
Outlook Classifi cation 236
List of Tables 240
Output (Tables A1–A4) 241
Infl ation (Tables A5–A7) 249
Financial Policies (Table A8) 255
Foreign Trade (Table A9) 256
Current Account Transactions (Tables A10–A12) 258
Balance of Payments and External Financing (Tables A13–A15) 264
Flow of Funds (Table A16) 268
Medium-Term Baseline Scenario (Table A17) 272
World Economic Outlook and Staff Studies for the World Economic Outlook, Selected Topics 273
Boxes
1.1 Is There a Credit Crunch? 9
1.2 Depreciation of the U.S. Dollar: Causes and Consequences 18
1.3 Multilateral Consultation on Global Imbalances: Progress Report 27

1.4 Dollar Depreciation and Commodity Prices 48
1.5 Why Hasn’t Oil Supply Responded to Higher Prices? 53
1.6 Oil Price Benchmarks 58
2.1 When Does Fiscal Stimulus Work? 70
CONTENTS
v
2.2 Petrodollars and Bank Lending to Emerging Markets 89
3.1 Assessing Vulnerabilities to Housing Market Corrections 113
4.1 Rising Car Ownership in Emerging Economies: Implications for Climate Change 142
4.2 South Asia: Illustrative Impact of an Abrupt Climate Shock 144
4.3 Macroeconomic Policies for Smoother Adjustment to Abrupt Climate Shocks 148
4.4 Catastrophe Insurance and Bonds: New Instruments to Hedge Extreme
Weather Risks 152
4.5 Recent Emission-Reduction Policy Initiatives 156
4.6 Complexities in Designing Domestic Mitigation Policies 160
5.1 How Does the Globalization of Trade and Finance Affect Growth?
Theory and Evidence 194
5.2 The Current Commodity Price Boom in Perspective 198
A1 Economic Policy Assumptions Underlying the Projections for Selected Economies 230
Tables
1.1 Overview of the World Economic Outlook Projections 2
1.2 Shares of Global GDP, 2007 45
1.3 Global Oil Demand and Production by Region 51
1.4 Food, Fuel, and Headline Infl ation 62
2.1 Advanced Economies: Real GDP, Consumer Prices, and Unemployment 66
2.2 Advanced Economies: Current Account Positions 67
2.3 Selected Asian Economies: Real GDP, Consumer Prices, and Current Account Balance 82
2.4 Selected Western Hemisphere Economies: Real GDP, Consumer Prices, and
Current Account Balance 83
2.5 Selected Emerging European Economies: Real GDP, Consumer Prices, and

Current Account Balance 85
2.6 Commonwealth of Independent States (CIS): Real GDP, Consumer Prices, and
Current Account Balance 93
2.7 Selected African Economies: Real GDP, Consumer Prices, and Current
Account Balance 96
2.8 Selected Middle Eastern Economies: Real GDP, Consumer Prices, and
Current Account Balance 98
3.1 Institutional Differences in National Mortgage Markets and the Mortgage
Market Index 107
3.2 Abnormal Contributions to GDP Growth Weakness One Year before Recessions 110
3.3 Features of House Price Cycles 111
3.4 Forecast Variance Decomposition: Housing Demand Shocks—Average
across Countries 117
3.5 Optimal Coeffi cients in the Taylor Rule 127
3.6 Estimates of the Error-Correction Model of Consumption 129
4.1 Losses in Real GNP, 2040 167
4.2 Baseline Growth Assumptions 178
4.3 Carbon-Based Emission Coeffi cients 179
4.4 Summary of the Baseline Scenario 180
4.5 Emission Intensities in the Baseline 181
4.6 Emission Reductions and Consumption Losses Following a Standardized
Carbon Price Shock 182
CONTENTS
vi
4.7 Comparison of Climate Policy Models 183
5.1 Cross-Sectional Regressions: Overall Trade 211
5.2 Cross-Sectional Regressions: Commodity Trade, Foreign Direct Investment (FDI) 212
5.3 Panel Regressions: Overall Trade 212
5.4 Panel Regressions: Commodity Trade, Foreign Direct Investment (FDI) 213
5.5 Panel Regressions: Institutions and Policies 214

Figures
1.1 Global Indicators 3
1.2 Current and Forward-Looking Indicators 4
1.3 Global Infl ation 5
1.4 Measures of Monetary Policy and Liquidity 6
1.5 Developments in Mature Credit Markets 7
1.6 Mature Financial and Housing Market Indicators 8
1.7 External Developments in Selected Advanced Economies 17
1.8 Emerging Economy Financial Conditions 23
1.9 External Developments in Emerging and Developing Economies 24
1.10 Growing Global Role of Emerging and Developing Economies 25
1.11 Global Outlook 31
1.12 Risks to the Global Outlook 32
1.13 Measures of the Output Gap and Capacity Pressures 34
1.14 Current Account Balances and Net Foreign Assets 35
1.15 Two Scenarios for the Global Economy 37
1.16 Purchasing-Power-Parity (PPP) Exchange Rate Revisions and Global Growth 44
1.17 Commodity and Petroleum Prices 47
1.18 World Oil Market Balances 52
1.19 Energy and Metal Prices and Metal Consumption Growth 57
1.20 Recent Developments in Major Food Crops 60
1.21 Macroeconomic Implications of High Commodity Prices 61
2.1 United States: Housing Cycles in Perspective 67
2.2 Western Europe: Tightening Lending Standards 77
2.3 Japan: Will Domestic Demand Be Able to Support Growth? 79
2.4 Emerging Asia: Trade Patterns and Growth Developments 81
2.5 Latin America: Long Road to Stronger Performance 84
2.6 Emerging Europe: Macroeconomic Vulnerabilities on the Rise 87
2.7 Commonwealth of Independent States (CIS): Infl ation Pressures Remain the
Central Concern 94

2.8 Sub-Saharan Africa: Vulnerability of Commodity Exports to Global Demand 95
2.9 Middle East: Strong Growth, Rising Infl ation 99
3.1 Mortgage Debt and Financial Innovation 105
3.2 Correlation of Real House Prices and Real Residential Investment
with the Output Gap 108
3.3 Labor Market Characteristics and the Contribution of Residential Investment
to the Business Cycle 111
3.4 Mortgage Market Index, Consumption and House Price Correlation, and
the Long-Run Marginal Propensity to Consume out of Housing Wealth 112
3.5 Share of Output Variation Explained by Housing Demand Shocks 117
CONTENTS
vii
3.6 Correlation between the Shares of Output and Housing Sector Variation
Explained by Housing Demand Shocks 118
3.7 Correlation between the Share of Output Variation Explained by Housing
Demand Shocks and the Mortgage Market Index 119
3.8 Housing and the Monetary Transmission Mechanism 119
3.9 Effect of Monetary Policy Shocks on Output and Housing Sector Variables in
the United States 120
3.10 Elasticity of Real Residential Investment, Real House Prices, and Output to a
100-Basis-Point Increase in Short-Term Interest Rates 121
3.11 Interest Rate Elasticity of Real Residential Investment, Real House Prices,
and Output and the Mortgage Market Index 122
3.12 Monetary Policy Counterfactuals 123
3.13 Macroeconomic Model with Housing as Collateral: Responses of Output
and Consumption to Shocks for Different Loan-to-Value (LTV) Ratios 125
3.14 Macroeconomic Model with Housing as Collateral: Response of Nominal
Interest Rates to a Positive Housing Demand Shock and a Negative Financial
Shock for Various Loan-to-Value (LTV) Ratios 126
4.1 Carbon Dioxide Energy-Related Emissions 135

4.2 Emission Forecasts 136
4.3 Mean GDP Losses at Various Levels of Warming 137
4.4 Damages from 2.5°C Warming by Region 138
4.5 Impact of Warming by Region and Sector 139
4.6 Physical Impact by 2080 140
4.7 Variation in Estimates of Damages from Climate Change 141
4.8 Weather Derivatives and Catastrophe Bonds 151
4.9 Global Emission Targets and Paths, 1990–2100 164
4.10 Uniform Carbon Tax, 2013–40 165
4.11 Total Costs of Mitigation, 2013–40 166
4.12 Cap-and-Trade System, 2013–40 169
4.13 International Transfers under the Cap-and-Trade System 170
4.14 Cap-and-Trade System for All Regions Based on Share of
World Population, 2013–40 171
4.15 Global Emissions from Energy Only, 2030 181
5.1 Trade in Goods and Services 191
5.2 Merchandise Exports of Emerging and Developing Economies 192
5.3 Gross Foreign Capital and Gross Foreign Liabilities 193
5.4 Commodity Prices 197
5.5 Values of Exports of Commodities and Manufactures 200
5.6 Volumes of Exports of Commodities and Manufactures 201
5.7 Patterns of Regional Trade 202
5.8 Foreign Direct Investment in Emerging and Developing Economies 203
5.9 Policy and Institutional Environment 204
5.10 Commodity Price Booms 205
5.11 Event Study of the Commodity Terms of Trade, 1970–2007 207
5.12 Explaining the Increase in Integration from the 1980s to the 2000s 214
A number of assumptions have been adopted for the projections presented in the World Economic
Outlook. It has been assumed (1) that real effective exchange rates will remain constant at their average
levels during January 30–February 27, 2008, except for the currencies participating in the European

exchange rate mechanism II (ERM II), which are assumed to remain constant in nominal terms rela-
tive to the euro; (2) that established policies of national authorities will be maintained (for specifi c
assumptions about fi scal and monetary policies in industrial countries, see Box A1); (3) that the aver-
age price of oil will be $95.50 a barrel in 2008 and $94.50 a barrel in 2009, and remain unchanged in
real terms over the medium term; (4) that the six-month London interbank offered rate (LIBOR) on
U.S. dollar deposits will average 3.1 percent in 2008 and 3.4 percent in 2009; (5) that the three-month
euro deposits rate will average 4.0 percent in 2008 and 3.6 percent in 2009; and (6) that the six-month
Japanese yen deposit rate will yield an average of 1.0 percent in 2008 and of 0.8 percent in 2009. These
are, of course, working hypotheses rather than forecasts, and the uncertainties surrounding them add
to the margin of error that would in any event be involved in the projections. The estimates and pro-
jections are based on statistical information available through end-March 2008.
The following conventions have been used throughout the World Economic Outlook:
. . . to indicate that data are not available or not applicable;
— to indicate that the fi gure is zero or negligible;
– between years or months (for example, 2006–07 or January–June) to indicate the years or
months covered, including the beginning and ending years or months;
/ between years or months (for example, 2006/07) to indicate a fi scal or fi nancial 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 of 1 percentage point).
In fi gures and tables, shaded areas indicate IMF staff projections.
If no source is listed on tables and fi gures, data are drawn from the World Economic Outlook
database.
When countries are not listed alphabetically, they are ordered on the basis of economic size.
Minor discrepancies between sums of constituent fi gures and totals shown are due to rounding.
As used in this report, the term “country” does not in all cases refer to a territorial entity that is a
state as understood by international law and practice. As used here, the term also covers some territo-
rial entities that are not states but for which statistical data are maintained on a separate and indepen-
dent basis.
ASSUMPTIONS AND CONVENTIONS

viii
This report on the World Economic Outlook is available in full on the IMF’s website, www.imf.org.
Accompanying it on the website is a larger compilation of data from the WEO database than in the
report itself, consisting of fi les containing the series most frequently requested by readers. These fi les
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, electronic mail, or telefax (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.
E-mail:

Telefax: (202) 623-6343
FURTHER INFORMATION AND DATA
ix
FURTHER INFORMATION AND DATA
x
The analysis and projections contained in the World Economic Outlook are integral elements of the
IMF’s surveillance of economic developments and policies in its member countries, of developments
in international fi nancial markets, and of the global economic system. The survey of prospects and
policies is the product of a comprehensive interdepartmental review of world economic developments,
which draws primarily on information the IMF staff gathers through its consultations with member
countries. These consultations are carried out in particular by the IMF’s area departments together
with the Policy Development and Review Department, the Monetary and Capital Markets Department,
and the Fiscal Affairs Department.
The analysis in this report has been coordinated in the Research Department under the general
direction of Simon Johnson, Economic Counsellor and Director of Research. The project has been
directed by Charles Collyns, Deputy Director of the Research Department, and Subir Lall, Acting

Division Chief, Research Department. Tim Callen helped coordinate the early stages of the project
before moving to a new assignment.
The primary contributors to this report are Roberto Cardarelli, Kevin Cheng, Stephan Danninger,
Selim Elekdag, Thomas Helbling, Deniz Igan, Florence Jaumotte, Ben Jones, Tim Lane, Valerie
Mercer-Blackman, Paul Mills, Gianni De Nicolò, Jonathan Ostry, Rodney Ramcharan, Alessandro
Rebucci, Alasdair Scott, Nikola Spatafora, Jon Strand, Natalia Tamirisa, Irina Tytell, Toh Kuan,
Gavin Asdorian, To-Nhu Dao, Stephanie Denis, Nese Erbil, Angela Espiritu, Elaine Hensle, Patrick
Hettinger, Susana Mursula, and Bennett Sutton. Ercument Tulun provided research assistance.
Mahnaz Hemmati, Laurent Meister, and Emory Oakes managed the database and the computer sys-
tems. Sylvia Brescia, Jemille Colon, and Sheila Tomilloso Igcasenza were responsible for word process-
ing. Other contributors include Eduardo Borensztein, Marcos Chamon, Hamid Faruqee, Lyudmyla
Hvozdyk, M. Ayhan Kose, Kornélia Krajnyák, Michael Kumhof, Douglas Laxton, Jaewoo Lee, Paolo
Mauro, Steven Symansky, Stephan Tokarick, and Johannes Wiegand. External consultants include
Warwick McKibbin, Tommaso Monacelli, Ian Parry, Luca Sala, Arvind Subramanian, Kang Yong Tan,
and Shang-Jin Wei. Linda Griffi n Kean of the External Relations Department edited the manuscript
and coordinated the production of the publication.
The analysis has benefi ted from comments and suggestions by staff from other IMF departments,
as well as by Executive Directors following their discussion of the report on March 19 and 21, 2008.
However, both projections and policy considerations are those of the IMF staff and should not be
attributed to Executive Directors or to their national authorities.
PREFACE
FOREWORD
xi
FOREWORD
This World Economic Outlook presents the IMF
staff’s view of the world economy in spring 2008, with
our assessment of current conditions and prospects
and with an in-depth analysis of several key elements
that will affect conditions and prospects in the months
and years ahead. This report has been prepared by

a team composed primarily of the staff of the World
Economic Studies division, ably led by Charles Collyns
and, since January, Subir Lall. I would also like to
recognize the particular contribution of Tim Callen,
who led this division for three years and who helped
shape this issue of the World Economic Outlook
during its design and development. In addition,
I must emphasize, as always, that other IMF staff,
both within the Research Department and across the
organization, have played critical roles in producing
this report, through direct contributions to all the
chapters and through a continual process of collegial
interaction and productive feedback.
The world economy has entered new and
precarious territory. The U.S. economy contin-
ues to be mired in the fi nancial problems that
fi rst emerged in subprime mortgage lending
but which have now spread much more broadly.
Strains that were once thought to be limited
to part of the housing market are now having
considerable negative effects across the entire
economy, with rising defaults, falling collat-
eral, and tighter credit working together to
create a powerful and hard-to-defeat fi nancial
decelerator.
In addition to serious problems at the inter-
section of credit and the real economy, the
United States remains plagued by profound
errors in risk management among its leading
fi nancial institutions. Problems that were once

thought to be limited to issues surrounding
liquidity in short-term money markets—and
thought capable of being dealt with as such—
have cascaded across much of the fi nancial
sector, triggering repeated waves of downgrades,
upward adjustment of losses for both U.S. and
European banks, and now an apparently unstop-
pable move toward some signifi cant degree of
global deleveraging.
This cutback in lending and the associated
attempt to reduce risks played a major role
in a most dramatic pair of events—both of
which happened as this World Economic Outlook
entered its fi nal stages of preparation. First,
one of the fi ve largest U.S. investment banks,
Bear Stearns, was sold under diffi cult circum-
stances— including the presumed imminence
of a far-reaching default. Second, and just as
headline-grabbing, were the virtually unprec-
edented steps taken by the Federal Reserve to
prevent Bear Stearns’s problems from spread-
ing. These steps have had a defi nite stabilizing
effect, at least for now.
In our view, the continuing deep correction
in the U.S. housing market and the unresolved
fi nancial sector problems have led the U.S. econ-
omy to the verge of recession. In fact, we are now
anticipating that the United States will indeed slip
into recession—meaning that it will experience
two or more quarters of negative growth—during

the course of 2008, before starting a moderate
recovery at some point during 2009.
The effects on the rest of the world are likely
to be signifi cant. We have already reduced our
expectations for growth in Europe and much of
the emerging world. Our revised global growth
forecast is 3.7 percent, down from 4.9 percent
in 2007, which represents a pronounced slow-
down. However, I would stress that achieving
growth even at this level will require that most
advanced economies experience only mild slow-
downs and that many emerging economies be
able to keep their rapid pace of growth largely
on track.
In addition to problems within the fi nancial
sector, there are two main short-run vulner-
abilities for the global economy, both of which
FOREWORD
xii
are covered in considerable detail in this World
Economic Outlook. The fi rst is that housing prices
may adjust downward signifi cantly in many other
advanced economies (fi rst fi gure). Although
Chapter 3 shows that the particular dynam-
ics of the housing market in the United States
are not matched by those in other countries,
it also shows that housing may now play a
more marked role in the business cycle more
broadly—as the nature of mortgage fi nancing
has changed and as valuations have increased

almost everywhere over the past 10 years.
The second potential vulnerability is, of
course, commodity prices. Chapter 5 examines
the role of commodity prices in contributing to
the strong performance of many emerging and
developing economies in recent years. It is strik-
ing how the surging tide of commodity prices
over the past fi ve years (second fi gure) has lifted
almost all commodity-based boats around the
world. Although there is some reason to believe
that the countries exporting commodities are
now better able than in the past to withstand a
serious downturn, we continue to urge caution:
commodity prices have fallen, on average, by 30
percent during signifi cant global slowdowns over
the past 30 years.
All eyes now turn to the world’s leading
emerging economies. They have come of eco-
nomic age in the past half-decade— diversifying
their exports, strengthening their domes-
tic economies, and improving their policy
frameworks. It is conceivable that their strong
momentum, together with some timely policy
adjustments, can sustain both their domestic
demand and the global economy.
At this moment, however, these emerging
economies fi nd themselves beset not by impend-
ing recession, but rather by infl ation pressures.
In particular, the fi nancial dynamics of dollar
depreciation and increasing fi nancial market

uncertainty have combined with continuing
strong demand growth in the emerging econo-
mies and sluggish supply responses by commod-
ity producers in such a way as to keep upward
pressure on food and energy prices despite
the darkening clouds over the global economy.
Number of Major Commodity Groups in Boom Phase and
Global Industrial Production
Sources: IMF, Commodity Price System; IMF, International Financial Statistics;
and IMF staff calculations.
Major commodity groups are defined as oil, metals, food, beverages, and
agricultural raw materials.
1960 65 70 75 80 85 90 95 2000 05
0
1
2
3
4
5
6
-15.0
-10.0
-5.0
0.0
5.0
10.0
15.0
Number of commodity groups in boom (left scale)
Global industrial production, annual growth in percent
(right scale)

1
1
Ireland
Netherlands
United Kingdom
Australia
France
Norway
Denmark
Belgium
Spain
Sweden
Italy
Japan
United States
Finland
Germany
Canada
Austria
-10
-5
0
5
10
15
20
25
30
35
House Price Gaps

(Percent)
Source: IMF staff calculations, as described in Box 3.1.
FOREWORD
xiii
Therefore, at the very time when preparations
for countercyclical measures would seem to be
warranted, leading emerging economies fi nd
themselves trying hard to take the edge off
infl ation.
These immediate issues are compelling, but
we must not lose sight of the longer-term chal-
lenges, including the global challenge of climate
change. The IMF can contribute to the impor-
tant current debate by analyzing the macroeco-
nomic consequences of climate change, which
can be far-reaching and quick-acting. Chapter
4 has a particular focus on the macroeconomic
impact of mitigation strategies and argues
that well-designed policy frameworks can limit
carbon and related emissions without having a
major negative effect on growth.
In addition to the compelling medium-term
case for containing emissions, we urgently need
a more coherent global approach to energy pric-
ing. It is essential that increases in fuel prices
be passed on to fi nal consumers, thus allowing
the price mechanism to play an appropriate role
across the global economy in reducing demand
(and limiting infl ation pressure) whenever sup-
ply conditions or fi nancial events push commod-

ity prices up. Attempts to protect consumers
from the true short-, medium-, or long-run costs
of using fossil fuels are likely to prove worse
than futile.
Simon Johnson
Economic Counsellor and Director, Research Department
Global Economic Environment
The global expansion is losing speed in the
face of a major fi nancial crisis (Chapter 1). The
slowdown has been greatest in the advanced
economies, particularly in the United States,
where the housing market correction contin-
ues to exacerbate fi nancial stress. Among the
other advanced economies, growth in western
Europe has also decelerated, although activity
in Japan has been more resilient. The emerging
and developing economies have so far been less
affected by fi nancial market developments and
have continued to grow at a rapid pace, led by
China and India, although activity is beginning
to slow in some countries.
At the same time, headline infl ation has
increased around the world, boosted by the
continuing buoyancy of food and energy prices.
In the advanced economies, core infl ation has
edged upward in recent months despite slow-
ing growth. In the emerging markets, headline
infl ation has risen more markedly, refl ecting
both strong demand growth and the greater
weight of energy and particularly food in con-

sumption baskets.
Commodity markets have continued to boom
despite slowing global activity. Strong demand
from emerging economies, which has accounted
for much of the increase in commodity con-
sumption in recent years, has been a driving
force in the price run-up, while biofuel-related
demand has boosted prices of major food crops.
At the same time, supply adjustments to higher
prices have lagged, notably for oil, and inven-
tory levels in many markets have declined to
medium- to long-term lows (see Appendix 1.2).
The recent run-up in commodity prices also
seems to have been at least partly due to fi nan-
cial factors, as commodities have increasingly
emerged as an alternative asset class.
The fi nancial shock that erupted in August
2007, as the U.S. subprime mortgage market was
derailed by the reversal of the housing boom,
has spread quickly and unpredictably to infl ict
extensive damage on markets and institutions
at the core of the fi nancial system. The fallout
has curtailed liquidity in the interbank market,
weakened capital adequacy at major banks, and
prompted the repricing of risk across a broad
range of instruments, as discussed in more
detail in the April 2008 Global Financial Stabil-
ity Report. Liquidity remains seriously impaired
despite aggressive responses by major central
banks, while concern about credit risks has

intensifi ed and extended far beyond the sub-
prime mortgage sector. Equity prices have also
retreated as signs of economic weakness have
intensifi ed, and equity and currency markets
have remained volatile.
These fi nancial dislocations and associated
deleveraging are affecting both bank and non-
bank channels of credit in the advanced econo-
mies, and evidence is gathering of a broad credit
squeeze—although not yet a full-blown credit
crunch. Bank lending standards in the United
States and western Europe are tightening,
the issuance of structured securities has been
curtailed, and spreads on corporate debt have
risen sharply. The impact is most severe in the
United States and is contributing to a further
deepening of the housing market correction. In
western Europe, the main spillovers have been
through banks most directly exposed to U.S.
subprime securities and disruptions in interbank
and structured securities markets.
Recent fi nancial market stress has also had
an impact on foreign exchange markets. The
real effective exchange rate for the U.S. dollar
has declined sharply since mid-2007 as foreign
investment in U.S. bonds and equities has been
dampened by reduced confi dence in both the
liquidity of and the returns on such assets, as
well as by the weakening of U.S. growth pros-
pects and interest rate cuts. The decline in the

xiv
EXECUTIVE SUMMARY
value of the U.S. dollar has boosted net exports
and helped bring the U.S. current account
defi cit down to less than 5 percent of GDP by
the fourth quarter of 2007, over 1½ percent
of GDP lower than its peak in 2006. The main
counterpart to the decline of the dollar has
been appreciation of the euro, the yen, and
other fl oating currencies such as the Canadian
dollar and some emerging economy currencies.
However, exchange rate movements have been
less marked for a number of countries with large
current account surpluses—notably China and
oil-exporting countries in the Middle East.
Direct spillovers to emerging and developing
economies have been less pronounced than in
previous periods of global fi nancial market dis-
tress, although capital infl ows have moderated
in recent months and issuance activity has been
subdued. A number of countries that had relied
heavily on short-term cross-border borrowing
have been affected more substantially. Trade
spillovers from the slowdown in the advanced
economies have been limited so far and are
more visible in economies that trade heavily with
the United States. As a result, growth among
emerging and developed economies has contin-
ued to be generally strong and broadly balanced
across regions, with many countries still facing

rising infl ation rates from buoyant food and fuel
prices and strong domestic demand.
Underpinning the resilience of the emerging
and developing economies are their increasing
integration into the global economy and the
broad-based nature of the current commodity
price boom, which have boosted exports, foreign
direct investment, and domestic investment in
commodity-exporting countries to a greater
degree than during earlier booms. As explored
in Chapter 5, commodity exporters have been
able to make progress toward diversifying their
export bases, including by increasing manufac-
turing exports, and the share of trade among the
emerging and developing economies themselves
has increased. Strengthened macroeconomic
frameworks and improved institutional envi-
ronments have been important factors behind
these favorable developments. As a result, the
growth performance of emerging and develop-
ing economies has become less dependent on
the advanced economy business cycle, although
spillovers have clearly not been eliminated.
Outlook and Risks
Global growth is projected to slow to 3.7 per-
cent in 2008, ½ percentage point lower than at
the time of the January World Economic Outlook
Update and 1¼ percentage points lower than the
growth recorded in 2007. Moreover, growth is pro-
jected to remain broadly unchanged in 2009. The

divergence in growth performance between the
advanced and emerging economies is expected to
continue, with growth in the advanced economies
generally expected to fall well below potential.
The U.S. economy will tip into a mild recession
in 2008 as the result of mutually reinforcing
cycles in the housing and fi nancial markets,
before starting a modest recovery in 2009 as
balance sheet problems in fi nancial institu-
tions are slowly resolved (Chapter 2). Activity
in western Europe is also projected to slow to
well below potential, owing to trade spillovers,
fi nancial strains, and negative housing cycles in
some countries. By contrast, growth in emerging
and developing economies is expected to ease
modestly but remain robust in both 2008 and
2009. The slowdown refl ects efforts to prevent
overheating in some countries as well as trade
and fi nancial spillovers and some moderation in
commodity prices.
The overall balance of risks to the short-term
global growth outlook remains tilted to the
downside. The IMF staff now sees a 25 percent
chance that global growth will drop to 3 per-
cent or less in 2008 and 2009—equivalent to a
global recession. The greatest risk comes from
the still-unfolding events in fi nancial markets,
particularly the potential for deep losses on
structured credits related to the U.S. subprime
mortgage market and other sectors to seriously

impair fi nancial system balance sheets and cause
the current credit squeeze to mutate into a
full-blown credit crunch. Interaction between
negative fi nancial shocks and domestic demand,
EXECUTIVE SUMMARY
xv
particularly through the housing market,
remains a concern for the United States and to
a lesser degree for western Europe and other
advanced economies. There is some upside
potential from projections for domestic demand
in the emerging economies, but these econo-
mies remain vulnerable to trade and fi nancial
spillovers. At the same time, risks related to
infl ationary pressures have risen, refl ecting the
price surge in tight commodity markets and the
upward drift of core infl ation.
Policy Issues
Policymakers around the world are facing a
diverse and fast-moving set of challenges, and
although each country’s circumstances differ,
in an increasingly multipolar world it will be
essential to meet these challenges broadly, tak-
ing full account of cross-border interactions. In
the advanced economies, the pressing tasks are
dealing with fi nancial market dislocations and
responding to downside risks to growth—but
policy choices should also take into account
infl ation risks and longer-term concerns. Many
emerging and developing economies still face

the challenge of ensuring that strong current
growth does not drive a buildup in infl ation
or vulnerabilities, but they should be ready to
respond to slowing growth and more diffi cult
fi nancing conditions if the external environ-
ment deteriorates sharply.
Advanced Economies
Monetary policymakers in the advanced
economies face a delicate balancing act between
alleviating the downside risks to growth and
guarding against a buildup in infl ation. In the
United States, rising downside risks to output,
amid considerable uncertainty about the extent,
duration, and impact of fi nancial turbulence
and the deterioration in labor market condi-
tions, justifi es the Federal Reserve’s recent deep
interest rate cuts and a continuing bias toward
monetary easing until the economy moves to a
fi rmer footing. In the euro area, although cur-
rent infl ation is uncomfortably high, prospects
point to its falling back below 2 percent during
2009, in the context of an increasingly negative
outlook for activity. Accordingly, the European
Central Bank can afford some easing of the
policy stance. In Japan, there is merit in keeping
interest rates on hold, although there would be
some limited scope to reduce interest rates from
already-low levels if there were a substantial dete-
rioration in growth prospects.
Beyond these immediate concerns, recent

fi nancial developments have fueled the continu-
ing debate about the degree to which central
banks should take asset prices into account in
setting monetary policy. In this context, Chapter
3 looks at connections between housing cycles
and monetary policy. It concludes that recent
experience seems to support giving greater
weight to house price movements in monetary
policy decisions, especially in economies with
more developed mortgage markets where
“fi nancial accelerator” effects have become more
pronounced. This could be achieved within a
risk-management framework for monetary policy
by “leaning against the wind” when house prices
move rapidly or when prices have moved out of
normal valuation ranges, although it would not
be feasible or desirable for monetary policy to
adopt specifi c house price objectives.
Fiscal policy can play a useful stabilizing role
in advanced economies in the event of a down-
turn in economic activity, although it should not
jeopardize efforts aimed at consolidating fi scal
positions over the medium term. In the fi rst
place, there are automatic stabilizers that should
provide timely fi scal support, without jeopardiz-
ing progress toward medium-term objectives. In
addition, there may be justifi cation for addi-
tional discretionary stimulus in some countries,
given present concern about the strength of
recessionary forces and concern that fi nancial

dislocations may have weakened the normal
monetary policy transmission mechanism, but
any such stimulus must be timely, well targeted,
and quickly unwound. In the United States,
where automatic stabilizers are relatively small,
the recent legislation to provide additional
EXECUTIVE SUMMARY
xvi
EXECUTIVE SUMMARY
xvii
stimulus for an economy under stress seems
fully justifi ed, and room may need to be found
for some additional public support for housing
and fi nancial markets. In the euro area, auto-
matic stabilizers are more extensive and should
be allowed to play out fully around a defi cit
path that is consistent with steady advance-
ment toward medium-term objectives. Coun-
tries whose medium-term objectives are well in
hand can provide some additional discretionary
stimulus if needed. However, in other countries,
the ability to allow even automatic stabilizers to
operate in full may be limited by high levels of
public debt and current adjustment plans that
are insuffi cient for medium-term sustainability.
In Japan, net public debt is projected to remain
at high levels despite recent consolidation
efforts. In the context of an economic down-
turn, automatic stabilizers could be allowed to
operate, but their impact on domestic demand

would be small, and there would be little scope
for additional discretionary action.
Policymakers need to continue strong efforts
to deal with fi nancial market turmoil in order to
avoid a full-blown crisis of confi dence or a credit
crunch. The immediate priorities, explored in
more detail in the April 2008 Global Financial
Stability Report, are to rebuild counterparty confi -
dence, reinforce the capital and fi nancial sound-
ness of institutions, and ease liquidity strains.
Additional initiatives to help support the U.S.
housing market, including possible use of the
public sector balance sheet, could help to reduce
uncertainties about the evolution of the fi nancial
system, although care would be needed to avoid
inducing undue moral hazard. Longer-term
reforms include improving mortgage market
regulation, promoting the independence of rat-
ing agencies, broadening supervision, strength-
ening the framework of supervisory cooperation,
and improving crisis resolution mechanisms.
Emerging and Developing Economies
Emerging and developing economies face the
challenges of controlling infl ation while being
alert to downside risks from the slowdown in the
advanced economies and the increased stress
in fi nancial markets. In some countries, further
monetary policy tightening may be needed to
keep infl ation under control. With a fl exible
exchange rate regime, currency appreciation

will tend to provide useful support for monetary
tightening. Countries whose exchange rates are
heavily managed vis-à-vis the U.S. dollar have less
room to respond because rising interest rates
may encourage heavier capital infl ows. China
and other countries that have diversifi ed econo-
mies would benefi t from moving toward more
fl exible regimes that would provide greater
scope for monetary policy. For many Middle
Eastern oil exporters, the exchange rate peg to
the U.S. dollar constrains monetary policy, and
it will be important that the current buildup in
fi scal spending be calibrated to account for the
cyclical position of these economies and that
priority be given to spending aimed at alleviat-
ing supply bottlenecks.
Fiscal and fi nancial policies can also play use-
ful roles in preventing overheating and related
problems. Expenditure restraint can help
moderate domestic demand, lessen the need
for monetary tightening, and ease pressures
from short-term capital infl ows. Vigilant fi nan-
cial supervision—promoting appropriately tight
lending standards and strong risk management
in domestic fi nancial institutions—can pay divi-
dends both by moderating the demand impulse
from rapid credit growth and by reducing the
buildup of balance sheet vulnerabilities.
At the same time, policymakers should be
ready to respond to a more negative external

environment, which could undercut trade
performance and stifl e capital infl ows. In many
countries, strengthened policy frameworks and
public sector balance sheets will allow for more
use than in the past of countercyclical monetary
and fi scal policies. In China, the consolidation
of the past few years provides ample room to
support the economy through fi scal policy, such
as by accelerating public investment plans and
advancing the pace of reforms to strengthen
social safety nets, health care, and education. In
many Latin American countries, well-established
EXECUTIVE SUMMARY
xviii
infl ation-targeting frameworks would provide
the basis for monetary easing in the event of
both a downturn in activity and an alleviation
of infl ation pressures. Automatic fi scal stabiliz-
ers could be allowed to operate, although there
would be little room for discretionary fi scal
stimulus, given still-high public debt levels. Some
emerging and developing economies that have
large current account defi cits or other vulner-
abilities and are reliant on capital infl ows may
need to respond by tightening policies promptly
to maintain confi dence.
Multilateral Initiatives and Policies
Broadly based efforts to deal with global
challenges have become indispensable. In the
event of a severe global downturn, there would

be a case for providing temporary fi scal sup-
port in a range of countries that have made
good progress in recent years in securing sound
fi scal positions. Providing fi scal stimulus across
a broad group of countries that would benefi t
from stronger aggregate demand could prove
much more effective than isolated efforts, given
the inevitable cross-border leakages from added
spending in open economies. It is still early to
launch such an approach, but it would be pru-
dent for countries to start contingency planning
to ensure a timely response in the event that
such support becomes necessary.
Reducing risks associated with global cur-
rent account imbalances remains an important
task. It is encouraging that some progress
is being made in implementing the strategy
endorsed by the International Monetary and
Financial Committee and the more detailed
policy plans laid out by participants in the
IMF-sponsored Multilateral Consultation
on Global Imbalances aimed at rebalanc-
ing domestic demand across countries, with
supportive movements in real exchange rates
(see Box 1.3). This road map remains relevant
but should be used fl exibly to take account of
the changing global context. Reducing trade
barriers also remains an important priority,
but the slow progress toward completing the
Doha Round has been disappointing. Rising

trade has been a key source of the recent strong
performance of the global economy—and
the recent progress toward global poverty
reduction—and a renewed push in this area
remains essential.
Recent commitments to developing a post-
Kyoto framework for joint action to address
climate change are very welcome. As discussed
in Chapter 4, efforts to adapt to and mitigate
the buildup of greenhouse gases have impor-
tant macroeconomic consequences. The chapter
fi nds that these macroeconomic consequences
can be contained, provided efforts to limit
emissions are based on effective carbon pricing
that refl ects the damages emissions infl ict. Such
carbon pricing should be applied across coun-
tries to maximize the effi ciency of abatement,
should be fl exible to avoid volatility, and should
be equitable so as not to put undue burdens on
the countries least able to bear them.
1
CHAPTER
The global expansion is losing speed in the face of
a major financial crisis. The slowdown has been
greatest in the advanced economies, particularly in
the United States, where the housing market correc-
tion continues to exacerbate financial stress. The
emerging and developing economies have so far been
less affected by financial market turbulence and have
continued to grow at a rapid pace, led by China and

India, although activity is beginning to moderate
in some countries. In the baseline, the U.S. economy
will tip into a mild recession in 2008 as a result of
mutually reinforcing housing and financial market
cycles, with only a gradual recovery in 2009, reflect-
ing the time needed to resolve underlying balance sheet
strains. Activity in the other advanced economies will
be sluggish in both 2008 and 2009 in the face of
trade and financial spillovers. Growth in the emerg-
ing and developing economies is also projected to slow,
although it should remain above long-term trends in
all regions. Risks to the global projections are tilted to
the downside, especially those related to the possibil-
ity of a full-blown credit crunch, while emerging and
developing economies will not be insulated from a
serious downturn in the advanced economies. Against
this background, policymakers in the advanced
economies must continue to grapple with the task of
restoring stability to housing and financial markets
while addressing downside risks to growth, without
jeopardizing inflation performance or longer-term
policy goals. Many emerging and developing econo-
mies still face the challenge of avoiding overheating
or any buildup in vulnerabilities, but policymakers
should be ready to respond judiciously to a deteriorat-
ing external environment.
Overview of Recent Developments
and Prospects: Divergence but
Not Decoupling
The course of the global economy over the

past six months has been shaped by the interac-
tion of two powerful but opposing forces: the
burgeoning fi nancial crisis that has shaken
the advanced economies and the rising tide of
the rapidly globalizing emerging economies.
Overall, global GDP measured at purchas-
ing-power-parity weights is estimated to have
increased 4.9 percent in 2007—well above trend
for the fourth consecutive year (Table 1.1 and
Figure 1.1).
1
Following a stronger-than-expected
third quarter, activity in the advanced econo-
mies decelerated quite sharply toward the end
of the year, particularly in the United States,
as the debacle in the U.S. subprime mortgage
market had knock-on effects across a broad
range of fi nancial markets and institutions
(Figure 1.2).
By contrast, the emerging and developing
economies continued to grow robustly, notwith-
standing some slowing in activity toward the
end of the year. China and India—which grew
11.4 percent and 9.2 percent, respectively, in
2007—continued to lead the way, but all regions
maintained robust rates of growth. The growth
momentum is being provided by strong pro-
ductivity gains as these countries progressively
integrate into the global economy, by terms-of-
trade increases for commodity producers as oil

and other raw material prices continue to soar,
and by strengthened policy frameworks.
Headline infl ation has increased around the
world, boosted by the continuing buoyancy
of food and energy prices (Figure 1.3). Rapid
increases in commodity prices have mainly
refl ected continued strong demand growth in
the emerging economies, which has accounted
1
Global and regional aggregates use country weights
calculated from the new purchasing-power-parity (PPP)
data published by the International Comparison Program
(ICP) in December 2007. This has resulted in a down-
ward shift in estimates of global growth in recent years
by about ½ percentage point relative to estimates in the
October 2007 World Economic Outlook. See Appendix 1.1
for more details.
1
GLOBAL PROSPECTS AND POLICIES
CHAPTER 1 GLOBAL PROSPECTS AND POLICIES
2
Table 1.1. Overview of the World Economic Outlook Projections
1
(Annual percent change unless otherwise noted)
Current Projections
Difference from
January 2008
WEO Update
2006 2007 2008 2009 2008 2009
World output 5.0 4.9 3.7 3.8 –0.5 –0.6

Advanced economies 3.0 2.7 1.3 1.3 –0.6 –0.8
United States 2.9 2.2 0.5 0.6 –1.0 –1.2
Euro area 2.8 2.6 1.4 1.2 –0.2 –0.7
Germany 2.9 2.5 1.4 1.0 –0.1 –0.7
France 2.0 1.9 1.4 1.2 –0.1 –1.0
Italy 1.8 1.5 0.3 0.3 –0.5 –0.7
Spain 3.9 3.8 1.8 1.7 –0.6 –0.8
Japan 2.4 2.1 1.4 1.5 –0.1 –0.2
United Kingdom 2.9 3.1 1.6 1.6 –0.2 –0.8
Canada 2.8 2.7 1.3 1.9 –0.5 –0.5
Other advanced economies 4.5 4.6 3.3 3.4 –0.4 –0.4
Newly industrialized Asian economies 5.6 5.6 4.0 4.4 –0.4 –0.4
Emerging and developing economies 7.8 7.9 6.7 6.6 –0.2 –0.4
Africa 5.9 6.2 6.3 6.4 –0.7 –0.2
Sub-Sahara 6.4 6.8 6.6 6.7 –0.3 –0.2
Central and eastern Europe 6.6 5.8 4.4 4.3 –0.2 –0.8
Commonwealth of Independent States 8.2 8.5 7.0 6.5 — –0.1
Russia 7.4 8.1 6.8 6.3 0.2 –0.2
Excluding Russia 10.1 9.6 7.4 7.0 –0.6 0.2
Developing Asia 9.6 9.7 8.2 8.4 –0.4 –0.4
China 11.1 11.4 9.3 9.5 –0.7 –0.5
India 9.7 9.2 7.9 8.0 –0.5 –0.2
ASEAN-5 5.7 6.3 5.8 6.0 –0.2 –0.2
Middle East 5.8 5.8 6.1 6.1 0.2 0.1
Western Hemisphere 5.5 5.6 4.4 3.6 0.1 –0.4
Brazil 3.8 5.4 4.8 3.7 0.3 –0.3
Mexico 4.8 3.3 2.0 2.3 –0.6 –0.7
Memorandum
European Union 3.3 3.1 1.8 1.7 –0.3 –0.7
World growth based on market exchange rates 3.9 3.7 2.6 2.6 –0.4 –0.7

World trade volume (goods and services) 9.2 6.8 5.6 5.8 –0.8 –1.1
Imports
Advanced economies 7.4 4.2 3.1 3.7 –1.3 –1.2
Emerging and developing economies 14.4 12.8 11.8 10.7 — –1.1
Exports
Advanced economies 8.2 5.8 4.5 4.2 –0.4 –0.9
Emerging and developing economies 10.9 8.9 7.1 8.7 –1.3 –1.0
Commodity prices (U.S. dollars)
Oil
2
20.5 10.7 34.3 –1.0 13.0 1.3
Nonfuel (average based on world commodity export weights) 23.2 14.0 7.0 –4.9 7.1 1.2
Consumer prices
Advanced economies 2.4 2.2 2.6 2.0 0.2 –0.1
Emerging and developing economies 5.4 6.4 7.4 5.7 1.0 0.3
London interbank offered rate (percent)
3
On U.S. dollar deposits 5.3 5.3 3.1 3.4 –0.9 –1.0
On euro deposits 3.1 4.3 4.0 3.6 –0.2 –0.4
On Japanese yen deposits 0.4 0.9 1.0 0.8 –0.1 –0.2
Note: Real effective exchange rates are assumed to remain constant at the levels prevailing during January 30–February 27, 2008. See the
Statistical Appendix for details on groups and methodologies.
1
Country weights used to construct aggregate growth rates for groups of countries were revised from those reported in the October 2007
World Economic Outlook to incorporate updated PPP exchange rates released by the International Comparison Program.
2
Simple 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
$70.95 in 2007; the assumed price is $95.50 in 2008 and $94.50 in 2009.
3
Six-month rate for the United States and Japan; three-month rate for the euro area.

3
for the bulk of the increase in commodity con-
sumption in recent years, and a sluggish supply
response, with fi nancial factors also playing some
role (Appendix 1.2). In the advanced econo-
mies, core infl ation has edged upward in recent
months despite slowing growth. In the emerging
economies, headline infl ation has risen more
markedly, refl ecting both strong demand growth
and the greater weight of energy and particularly
food in consumption baskets.
Global growth is projected to drop to 3.7 per-
cent in 2008 and to continue at about the same
pace in 2009. Financial market conditions are
likely to remain extremely diffi cult until there
is greater clarity about the extent and distribu-
tion of losses on structured securities, until core
fi nancial institutions are able to rebuild capital
and strengthen balance sheets, until the frame-
work for structured fi nance and related invest-
ment vehicles is made more robust, and until
the risk of widespread deleveraging and associ-
ated asset price declines is more clearly con-
tained. The continuing housing correction in
the United States will remain a drag on demand
and a source of uncertainty for fi nancial mar-
kets. As a result, the U.S. economy is projected
to tip into mild recession in 2008, despite the
substantial monetary and fi scal support that
is now in train. Other advanced economies

will also slow in the face of trade and fi nancial
spillovers, with housing markets a source of
drag in some European countries. Emerging
and developing economies are also expected to
decelerate, refl ecting efforts to prevent overheat-
ing in some countries, as well as spillovers from
the advanced economies and some modera-
tion in commodity prices, although growth will
continue to be above trend in all regions. The
risks around this lower baseline remain tilted to
the downside, particularly from possible further
negative fi nancial developments.
The next sections of this chapter examine
two key issues: fi rst, the likely magnitude of the
impact of fi nancial turbulence on economic
activity, focusing on the advanced economies,
and second, the extent to which emerging and
developing economies can decouple from a
-4
0
4
8
12
16
0
2
4
6
8
10

-2
-1
0
1
2
3
4
5
6
0
2
4
6
8
World Real per Capita GDP
Trend,
1970–2006
Trend,
1970–2006
World Trade Volume
(goods and services)
World Real GDP Growth
Figure 1.1. Global Indicators
(Annual percent change unless otherwise noted)
1
While the global economy continued to grow robustly in 2007, for the fourth
consecutive year, performance has diverged: activity in the advanced economies
slowed, while emerging and developing economies continued to grow rapidly.
Looking ahead, growth is expected to decline in 2008 and 2009 in both advanced
and emerging and developing economies.

Trend,
1970–2006
Source: IMF staff estimates.
Shaded areas indicate IMF staff projections. Aggregates are computed on the basis of
purchasing-power-parity (PPP) weights unless otherwise noted.
Average growth rates for individual countries, aggregated using PPP weights; the
aggregates shift over time in favor of faster-growing countries, giving the line an upward
trend.
2
1
2
2
2
0
5
10
15
20
25
Consumer Prices
Advanced
economies
Emerging and
developing economies
Real GDP Growth
Advanced
economies
0
2
4

6
8
Global Imbalances
(absolute sum of current
account balances in percent
of world GDP)
1970 75 80 85 90 95 2000 05 10
1970 75 80 85 90 95 2000 05 10
1970 75 80 85 90 95 2000 05 10
1970 75 80 85 90 95 2000 05 10
197075 80 85 90 95 2000 05 10
1970 75 80 85 90 95 2000 05 10
Emerging and
developing economies
(median)
OVERVIEW OF RECENT DEVELOPMENTS AND PROSPECTS: DIVERGENCE BUT NOT DECOUPLING
CHAPTER 1 GLOBAL PROSPECTS AND POLICIES
4
downturn in the United States and western
Europe. The chapter then discusses the risks to
the outlook and the policy implications.
Financial Market Turbulence: Rocky Ride
for the Advanced Economies
The fi nancial market crisis that erupted in
August 2007 has developed into the largest
fi nancial shock since the Great Depression,
infl icting heavy damage on markets and institu-
tions at the core of the fi nancial system. The tur-
moil was initiated by rapidly rising defaults on
subprime mortgages in the context of a major

U.S. housing correction (discussed in Chapter
2) and the consequent blowout in spreads on
securities backed by such mortgages, including
on collateralized debt obligations structured to
attract high credit ratings. However, the fallout
rapidly spread through an excessively lever-
aged fi nancial system to curtail liquidity in the
interbank market, to weaken capital adequacy
and force the emergency resolution of major
fi nancial intermediaries, to deeply disrupt struc-
tured credit markets, and to prompt a repricing
of risk across a broad range of instruments, as
described in more detail in the April 2008 Global
Financial Stability Report.
One of the most dramatic aspects of this crisis
has been an unprecedented loss of liquidity,
with three-month interbank rates shooting up
far in excess of policy targets for overnight rates
(Figure 1.4). This occurred as banks sought
to conserve their own liquidity in the face of
pressures to absorb assets from off-balance-sheet
vehicles for which they were no longer able
to obtain funding and amid rising uncertainty
about the extent and distribution of banks’
losses on holdings of subprime-mortgage-related
securities and other structured credits. Liquidity
shortages spread more broadly as increasingly
cautious banks cut back on credit lines and
increased haircuts and margin calls on other
fi nancial intermediaries.

Major central banks responded aggressively
to the loss of liquidity by providing large-scale
access to short-term funding through exist-
-40
-20
0
20
40
60
80
100
120
140
160
-15
-10
-5
0
5
10
15
20
25
30
35
40
45
20
40
60

80
100
120
140
160
180
-24
-20
-16
-12
-8
-4
0
4
8
35
40
45
50
55
60
65
70
-50
-40
-30
-20
-10
0
10

20
Business Confidence
(index)
Euro area
(right scale)
Consumer Confidence
(index)
United States
(left scale)
Japan
(right scale)
United States
(left scale)
Euro area
(right scale)
-10
-5
0
5
10
15
20
Industrial Production
(annualized percent change
from three months prior)
World
Global Trade
(annualized percent change from
three months prior in SDR terms)
World

Advanced
economies
1
Figure 1.2. Current and Forward-Looking Indicators
(Percent change from a year ago unless otherwise noted)
Industrial production has moderated in the advanced economies, where there has
also been a marked deterioration in business and consumer confidence indicators
in recent months. Activity indicators for emerging economies have remained buoyant,
while trade has rebounded in early 2008 as a result of commodity price increases.
0
2
4
6
8
10
Advanced
economies
1
World
Sources: Business confidence for United States, Institute for Supply Management; for
euro area, European Commission; for Japan, Bank of Japan. Consumer confidence for
United States, Conference Board; for euro area, European Commission; for Japan,
Cabinet Office; for all others, Haver Analytics.
Australia, Canada, Denmark, euro area, Japan, New Zealand, Norway, Sweden,
Switzerland, United Kingdom, and United States.
Argentina, Brazil, Bulgaria, Chile, China, Colombia, Czech Republic, Estonia, Hong Kong
SAR, Hungary, India, Indonesia, Israel, Korea, Latvia, Lithuania, Malaysia, Mexico,
Pakistan, Peru, Philippines, Poland, Romania, Russia, Singapore, Slovak Republic, South
Africa, Taiwan Province of China, Thailand, Turkey, Ukraine, and Rep. Bolivariana de
Venezuela.

Japan’s consumer confidence data are based on a diffusion index, where values greater
than 50 indicate improving confidence.
Data for China, India, Pakistan, and Russia are interpolated.
1
2
3
Domestic Demand Growth
(percent)
Emerging
economies
2,4
Emerging
economies
2
Japan
(left scale)
3
4
2000 02 04 06 Jan.
08
2000 02 04 06 Jan.
08
Feb.
08
Mar.
08
07:
Q4
Advanced
economies

1
Commodity Price Index
(three-month average of percent
change from a year prior)
Fuel
Food
Feb.
08
Metals
2000 02 04 06 2000 02 04 06
2000 02 04 06 2000 02 04 06
Emerging
economies
2
5
ing facilities, with mixed initial success. With
liquidity premiums remaining at high levels, in
December the European Central Bank (ECB)
further expanded its operations, the Federal
Reserve and the Bank of England substantially
broadened both the range of collateral accepted
and the range of borrowers with access to
central bank funds, and major central banks
announced a coordinated initiative to ensure
adequate liquidity, including the provision
of swap lines by the Federal Reserve to allow
European central banks to extend dollar liquid-
ity. The Federal Reserve took further actions in
March, including opening an effective discount
window for prime dealers. A number of central

banks have also eased monetary policy stances
in refl ection of increasing downside risks to the
growth outlook over this period. Most dramati-
cally, the Federal Reserve has lowered the fed-
eral funds rate by 300 basis points since August
2007, while the Bank of Canada and the Bank
of England have also reduced policy rates and
the ECB and the Bank of Japan have forgone
further interest rate increases. In the United
Kingdom, the authorities also provided a full
deposit guarantee to help restore depositor con-
fi dence after the collapse of a major mortgage
provider. Term premiums remain substantially
higher than usual more than seven months after
the initial outbreak of turbulence.
The persistence of liquidity problems has
been due in large part to increasing concerns
about credit risks. Credit spreads have contin-
ued to widen in recent months, amid increasing
gloominess about the outlook as well as mount-
ing concern about the general soundness of
structured products and investment vehicles
(Figure 1.5). With continuing deterioration of
U.S. housing market conditions, particularly in
the subprime market segment, prices of mort-
gage-related securities have continued to fall.
Moreover, spreads have risen sharply across
other related market segments, including securi-
ties backed by credit cards, auto loans, student
loans, and commercial mortgages, as a result of

concerns about rising default rates, excessive
leverage, and questionable securitization tech-
0
1
2
3
4
5
6
7
Sources: Haver Analytics; and IMF staff calculations.
Australia, Canada, Denmark, euro area, Japan, New Zealand, Norway, Sweden, United
Kingdom, and United States.
Brazil, Bulgaria, Chile, China, Estonia, Hong Kong SAR, Hungary, India, Indonesia,
Korea, Malaysia, Mexico, Poland, Singapore, South Africa, Taiwan Province of China, and
Thailand.
Personal consumption expenditure deflator.
Ten-year government bond yield minus ten-year inflation-linked government bond yield.
1
2
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
Global Aggregates
0

1
2
3
4
5
6
7
Headline Inflation
World
Advanced
economies
1
Emerging
economies

2
Core Inflation
World
Advanced
economies
1
-2
-1
0
1
2
3
4
5
Advanced Economies—Headline

Inflation
Euro area
Japan
-2
-1
0
1
2
3
4
5
Advanced Economies—Core
Inflation
Japan
Euro area
Figure 1.3. Global Inflation
(Twelve-month change of the consumer price index unless otherwise noted
)
Headline inflation spiked in late 2007 and early 2008, reflecting the impact of rising
energy and, particularly, food prices. Core inflation and inflation expectations have
edged upward.
Emerging
economies

2
Advanced Economies—Inflation
Expectations
3
2002 03 04 05 06 Feb.
08

2002 03 04 05 06 Feb.
08
2002 03 04 05 06 Feb.
08
2002 03 04 05 06 Feb.
08
2002 03 04 05 06 Mar.
08
United States
3
United States
3
-5
0
5
10
15
20
25
Emerging Economies—Headline
Inflation
India
China
2002 03 04 05 06 Feb.
08
Brazil
Russia
United States
Euro area
Japan

4
4
07 07
07 07
07 07
FINANCIAL MARKET TURBULENCE: ROCKY RIDE FOR THE ADVANCED ECONOMIES
CHAPTER 1 GLOBAL PROSPECTS AND POLICIES
6
niques. In this context, there has been intensi-
fi ed concern about counterparty risk as banks
have been only partially successful in sustaining
capital in the face of mounting losses, with a
major U.S. investment bank being sold on an
emergency basis with support from the Federal
Reserve. Moreover, a number of hedge funds
and other highly leveraged institutions have
run into serious diffi culties as banks increased
margin calls on their lines of credit, raising the
threat of forced asset sales. At the same time,
there are rising questions about the soundness
of the credit-default-swap market, particularly
given the weakening fi nancial positions of the
monoline insurers that provide cover for credit
defaults.
Equity prices also have retreated, particularly
in early 2008 when signs of economic weakness
intensifi ed, and fi nancial sector stocks have been
hit particularly hard (Figure 1.6). Measures of
volatility in equity and currency markets have
remained elevated. By contrast, rates on govern-

ment bonds have declined sharply, and invest-
ment in commodity markets has escalated, as
investors seek alternative asset classes.
What will be the overall economic impact
of these fi nancial market dislocations? Recent
episodes of turbulence in securities markets
generally have not had a major impact on
activity (see Box 1.2 of the October 2007 World
Economic Outlook). There is somewhat more
evidence to suggest that episodes of banking
distress have put a squeeze on credit, but even
in these cases it is hard to disentangle the
consequences of restraints on credit supply
from those of the declining credit demand that
accompanies recession (Box 1.1). During previ-
ous periods of turbulence, various segments
of the fi nancial system have been able, at least
partly, to compensate for diffi culties experi-
enced in others.
However, experience during these episodes
may not provide much guidance for the current
unprecedented situation. Of particular concern,
the global economy is now facing a widespread
deleveraging as mechanisms for credit creation
have been damaged in both the banking system
-6
-4
-2
0
2

4
6
8
-2
0
2
4
6
8
10
12
-100
-50
0
50
100
150
200
250
300
Figure 1.4. Measures of Monetary Policy and Liquidity
(Interest rates in percent unless otherwise noted)
Central banks have responded aggressively to a drying up of liquidity in interbank
markets by providing large-scale access to short-term funding. The Federal Reserve
responded to increasing downside risks to activity by cutting the federal funds rate
rapidly, while the European Central Bank and the Bank of Japan have kept policy rates
on hold.
0
1
2

3
4
5
6
7
Euro
area
Nominal Short-Term Interest
Rates
Japan
TED Spreads
(basis points)
United
States
Sources: Bloomberg Financial Markets; Eurostat; Haver Analytics; Merrill Lynch; OECD
Economic Outlook; and IMF staff calculations.
Three-month treasury bills.
Relative to headline inflation. Measured as deviations from 1990–2007 average.
The Taylor rate depends on (1) the neutral real rate of interest, which in turn is a function
of potential output growth, (2) the deviation of consumer price inflation from the inflation
target, and (3) the output gap. See Chapter 2 of the September 2004 World Economic
Outlook.
Weighted average of change in nominal effective exchange rate, overnight LIBOR,
three-month LIBOR, 10-year government bond, and corporate high-yield bond rates.
Weights estimated by IMF staff.
Three-month LIBOR rate minus three-month government bill rate.
Change over three years for euro area, Japan, and United States (G3), denominated in
U.S. dollars.
1
Deviation from Taylor Rule

2000 02 04 06 Feb.
08
2000 02 04 06
-4
-3
-2
-1
0
1
2
3
98.5
99.0
99.5
100.0
100.5
101.0
101.5
102.0
Real Short-Term Interest Rates
Financial Conditions Index
United States
Euro area
Japan
2
Feb.
08
2000 06
Mar.
08

02 04
2005 0706
Quantitative Liquidity Measures
(percent of G3 GDP)
07:
Q4
1970 75 95 2000
2
3
4
1
5
80 85 90
Base money
plus reserves
Base
money
Reserves
Euro area
United States
Japan
U.S.
dollar
Japanese
yen
Mar.
08
3
4
5

6
6
Euro
07:
Q4
Japan
United
States
Euro area
1990 94 98 2002 06