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International Monetary Fund | April 2013 xiii

FoREWoRD

What was until now a two-speed recov-

ery, strong in emerging market and

developing economies but weaker in

advanced economies, is becoming a

three-speed recovery. Emerging market and develop-

ing economies are still going strong, but in advanced

economies, there appears to be a growing biurcation

between the United States on one hand and the euro

area on the other.

Tis is reected in our orecasts. Growth in emerg-

ing market and developing economies is orecast to

reach 5.3 percent in 2013 and 5.7 percent in 2014.Growth in the United States is orecast to be 1.9 per-

cent in 2013 and 3.0 percent in 2014. In contrast,

growth in the euro area is orecast to be 0.3 percent

in 2013 and 1.1 percent in 2014.

Te growth gure or the United States or 2013

may not seem very high, and indeed it is insufcient

to make a large dent in the still-high unemploy-

ment rate. But it will be achieved in the ace o a

very strong, indeed overly strong, scal consolidation

o about 1.8 percent o GDP. Underlying private

demand is actually strong, spurred in part by the

anticipation o low policy rates under the Federal

Reserves orward guidance and by pent-up demand

or housing and durables.

Te orecast or negative growth in the euro area

reects not only weakness in the periphery but also

some weakness in the core. Germanys growth is

strengthening but is still orecast to be less than 1

percent in 2013. Frances growth is orecast to be

negative in 2013, reecting a combination o scal

consolidation, poor export perormance, and low

condence. Tis may call into question the ability o

the core to help the periphery, i and when needed.Most euro area periphery countries, notably Italy and

Spain, are expected to have substantial contractions

in 2013. Te process o internal devaluation is slowly

taking place, and most o these countries are slowly

becoming more competitive. External demand, how-

ever, is just not strong enough to compensate or weak

internal demand. Adverse eedback loops between

weak banks, weak sovereigns, and low activity are still

reinorcing each other.

Japan is orging a path o its own. Ater many years

o deation, and little or no growth, the new govern-

ment has announced a new policy, based on aggressive

quantitative easing, a positive ination target, scal

stimulus, and structural reorms. Tis policy will

boost growth in the short term, and this is reected

in our orecast o 1.6 percent growth or 2013. Given

the high level o public debt, however, embarking ona scal stimulus in the absence o a medium-term

scal consolidation plan is risky; it increases the prob-

ability that investors will require a risk premium, and

that this will lead in turn to debt unsustainability.

In contrast to this mixed picture or the advanced

economies, emerging market economies are doing

well. In the past, the conditions that prevail today

high commodity prices, low interest rates, large capital

inowswould oten have led to credit booms and

overheating. Tis time, however, policymakers have

generally succeeded in keeping aggregate demand

in line with potential. At the same time, potential

growth has itsel apparently declined in a number o

major emerging market economies, relative to precrisis

trends. Although circumstances vary across countries,

the evidence suggests that some o this decline has its

source in policy-induced distortions, and those should

be addressed.

Turning to policies:

In the United States, the ocus should be on den-

ing the right path o consolidation. While the seques-

ter has decreased worries about debt sustainability, itis the wrong way to proceed. Tere should be both

less and better scal consolidation now and a commit-

ment to more scal consolidation in the uture.

In the euro area, institutional progress has been

made over the past year, in particular on creating a

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world economic outlook: Hopes, realities, risks

road map or a banking union. Te Outright Mon-

etary ransactions program oered by the European

Central Bank, even i not yet taken up, has reduced

tail risks. Yet this is not enough. Te interest rates ac-

ing borrowers in periphery countries are still too high

to secure the recovery, and there is a need or urtherand urgent measures to strengthen banks, without

weakening the sovereigns. Te weakness o private

demand also suggests that countries that have scope

to do so should allow automatic stabilizers to operate,

and some countries with scal space should go even

beyond this.

Emerging market economies ace dierent chal-

lenges, one o which is handling capital ows.

Fundamentally attractive prospects in emerging

market economies, together with low interest rates in

advanced economies, are likely to lead to continuing

net capital inows and exchange rate pressure in many

emerging market economies. Tis is a desirable pro-

cess and part o the global rebalancing that must take

place i the world economy is to get back to health. At

the same time, as we have seen, capital ows can be

volatile, making macroeconomic management more

difcult. Te challenge or recipient countries is toaccommodate the underlying trends while reducing

the volatility o the ows when they threaten macro or

nancial stability.

In short, recent good news about the United States

has come with renewed worries about the euro area.

Given the strong interconnections between countries,

an uneven recovery is also a dangerous one. Some tail

risks have decreased, but it is not time or policymak-

ers to relax.

Olivier Blanchard

Economic Counsellor

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International Monetary Fund | April 2013 xv

ExECuTIvE SuMMARy

Global economic prospects have improved

again but the road to recovery in the

advanced economies will remain bumpy.

World output growth is orecast to reach

3 percent in 2013 and 4 percent in 2014. In

advanced economies, activity is expected to gradually

accelerate, starting in the second hal o 2013. Private

demand appears increasingly robust in the United

States but still very sluggish in the euro area. In

emerging market and developing economies, activity

has already picked up steam.

Better, bt Bmp and Diergent, Prspectsr Adanced Ecnmies

Over the past six months, advanced economy poli-

cymakers have successully deused two o the biggest

short-term threats to the global recovery, the threat

o a euro area breakup and a sharp scal contraction

in the United States caused by a plunge o the s-

cal cli. In response, nancial markets have rallied

on a broad ront. Moreover, nancial stability has

improved, as underscored in the April 2013 Global

Financial Stability Report(GFSR).

Te nancial market rally has been helping eco-

nomic recovery by improving unding conditions and

supporting condence, but growth prospects appear

broadly unchanged. While U.S. private demand has

been showing strength as credit and housing markets

are healing, larger-than-expected scal adjustment is

projected to keep real GDP growth at about 2 per-

cent in 2013. In the euro area, better conditions

or periphery sovereigns are not yet passing through

to companies and households, because banks are

still hobbled by poor protability and low capital,constraining the supply o credit. Also, in many

economies activity will be held back by continued

scal adjustment, competitiveness problems, and

balance sheet weaknesses. Furthermore, new political

and nancial risks that could put a damper on the

recovery have come to the ore. Accordingly, real GDP

is projected to contract relative to 2012, by about

percent o GDP. Japan, by contrast, will see a s-

cal- and monetary-stimulus-driven rebound, with real

GDP growth reaching 1 percent.

Overall, the annual growth orecast or advanced

economies in 2013a modest 1 percentis no bet-

ter than the outcome or 2012. Tat said, assuming

that policymakers avoid setbacks and deliver on their

commitments, the projections in this World Economic

Outlook(WEO) build on continued easing o the

brakes on real activity. Consequently, in 2013, ater

a weak rst hal, real GDP growth in the advanced

economies is projected to rise above 2 percent or therest o the year and to average 2 percent in 2014,

spurred by U.S. growth o about 3 percent.

Reaccelerating Actiit in Emerging Marketand Deelping Ecnmies

Tere was a noticeable slowdown in the emerging

market and developing economies during 2012, a

reection o the sharp deceleration in demand rom

key advanced economies, domestic policy tighten-

ing, and the end o investment booms in some o

the major emerging market economies. But with

consumer demand resilient, macroeconomic policy

on hold, and exports reviving, most economies in

Asia and sub-Saharan Arica and many economies

in Latin America and the Commonwealth o Inde-

pendent States are now seeing higher growth. Te

recovery should again gain speed in emerging Europe

as demand rom advanced Europe slowly picks up.

However, economies in the Middle East and North

Arica continue to struggle with difcult internal tran-

sitions. And a couple o economies in South America

are acing high ination and increasing exchangemarket pressure.

Tere is good news emanating rom developing

economies. Even as estimates o potential growth have

been marked down in recent years or some o the

larger emerging markets, it has been steadily improv-

ing elsewhere. In act, Chapter 4 underscores that the

prospects o many o todays dynamic low-income

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world economic outlook: Hopes, realities, risks

countries appear stronger than those o their peers

during the 1960s and 1970s.

Mre Smmetric Risks

Notwithstanding old dangers and new turbulence,the near-term risk picture has improved as recent

policy actions in Europe and the United States have

addressed some o the gravest short-term risks. In

the euro area, the main short-term dangers now

revolve around adjustment atigue, weak balance

sheets, broken credit channels in the periphery, and

insufcient progress toward stronger economic and

monetary union at the euro area level. In the United

States and Japan, risks relate mainly to medium-term

scal policy. Over the short term, a ailure by the

U.S. Congress to replace the automatic spending cuts

(budget sequester) with back-loaded measures at theend o the current scal year would entail somewhat

lower-than-projected growth in late 2013 and beyond.

O much greater concern would be a ailure to raise

the debt ceilingthe risk o such sel-destructive

inaction, however, appears low. Over the medium

term, downside risks revolve around the absence o

strong scal consolidation plans in the United States

and Japan; high private sector debt, limited policy

space, and insufcient institutional progress in the

euro area, which could lead to a protracted period o

low growth; distortions rom easy and unconventional

monetary policy in many advanced economies; andoverinvestment and high asset prices in many emerg-

ing market and developing economies. Unless policies

address these risks, global activity is likely to suer

periodic setbacks. By the same token, a stronger-than-

projected policy response could also oster a stronger

recovery in activity.

Plicmakers Cannt Afrd t Rela TheirEfrts

In advanced economies, policy should use all pru-

dent measures to support sluggish demand. However,

the risks related to high sovereign debt limit the scal

policy room to maneuver. Tere is no silver bullet

to address all the concerns about demand and debt.

Rather, scal adjustment needs to progress gradually,

building on measures that limit damage to demand

in the short term; monetary policy needs to stay

supportive o activity; nancial policies need to help

improve the pass-through o monetary policy; and

structural and other policies need to spur potential

output and global demand rebalancing. Regarding

monetary policy, one key nding o Chapter 3 is

that ination expectations have become much better

anchored, aording central banks greater leeway tosupport activityalthough they must be mindul o

nancial stability risks emanating rom their policies,

as discussed in detail in the April 2013 GFSR.

Te critical scal policy requirements are persis-

tent but gradual consolidation and, or the United

States and Japan, the design and implementation o

comprehensive medium-term decit-reduction plans.

Tese requirements are urgent or Japan, given the

signicant risks related to the renewal o stimulus in

an environment o very high public debt levels. In the

United States, it is worrisome that ater three years

o deliberations, policymakers have not agreed on acredible plan or entitlement and tax reorm and that

improvement in near-term prospects seems to have

come with a decreased sense o urgency or progress.

Te specic requirements and country details are

discussed in the April 2013 Fiscal Monitor.

Te April 2013 GFSR underscores the need or

urther nancial repair and reorm, including restruc-

turing weak banks and, in some cases, oering house-

holds and weak corporate debtors avenues other than

traditional bankruptcy or dealing with debt overhang.

Previous WEO reports also stressed the critical role

o structural reorms in rebuilding competitivenessand boosting medium-term growth prospects in many

euro area economies.

In emerging market and developing economies,

some tightening o policies appears appropriate over

the medium term. Te tightening should begin with

monetary policy and be supported with prudential

measures as needed to rein in budding excesses in

nancial sectors. Eventually, policymakers should

also return scal balances to levels that aord ample

room or policy maneuvering. Some will need to take

signicant action now; others will need only limited

improvements over the medium term.

Plic Spillers

Te bumpy recovery and skewed macroeconomic

policy mix in advanced economies are complicating

policymaking in emerging market economies. Concerns

resuraced once again recently, when looser monetary

xvi International Monetary Fund | April 2013