The financial crisis in Europe has commenced a “perilous new phase” that could handicap global economic growth even with a best case scenario, so said a report from the International Monetary Fund on Tuesday.
To make matters worse, the threat is growing that Europe’s difficulties could become even less stable, leading to a failure in lending as well as investment and production that would cause a severe recession in Europe, as opposed to the mild recession that the IMF is now predicting.
In the latest World Economic Outlook, released by the IMF, the global economy is anticipated to grow 3.3% in 2012, much slower than just four months ago when the IMF was expecting 4% growth. Global growth should improve a bit next year to 3.9%, but developed economies through Europe, North America and the Pacific Rim in all likelihood will keep bumping along with growth rates under 3% for the next two years.
Forecasts by the IMF’s are usually taken with a pinch of salt. The real interest lies in the examination of the upside and downside risks, and that’s where it gets alarming.
In its baseline forecast, the IMF takes for granted that European policy makers will be able to steer clear of a fatal breakup of the euro zone and will be capable of calming any concern about sovereign debt and bank balance sheets.
If, for whatever reason that turns out to not be the case, the IMF sees a series of events known as an “adverse feedback loop” between sovereign debt and bank funding needs where increased unease about debt drives governments into “more front-loaded fiscal consolidation, which depresses near-term demand and growth.”
“Front Loaded” means there will be more of the pain up front. “Fiscal Consolidation” is about reforms (think increases) in revenues (taxes, etc.) and reforms (think cuts) in expenditure (entitlements, etc.). There is an inherent time delay for adoption, implementation and stabilization, between decisions and their full impact upon the revenue deficit.
In the advent that the IMF cannot avoid the dire breakup, Europe’s economy would contract at a 4.5% annual rate, as opposed to the mild 0.5% turn down predicted in the IMF’s baseline forecast. The ensuing recession wouldn’t be as bad as 2008’s downturn, but it would cut global growth to just 1.3% in 2012.
There are other foreseen dangers as well from an economic hard landing in China to a cut-off in oil supplies. Plus any “excessive fiscal tightening” in the U.S. would probably result in lower growth.
The IMF report paints a gloomy picture on the global economy, and even four years after the beginning of the recession things remain in a very fragile state in our ongoing financial crisis.