Washington: The current global recession is likely to be unusually long and severe and the recovery sluggish because it sprang from a financial crisis, the International Monetary Fund said on Thursday.
New IMF analysis shows recessions tied to a financial crisis, like the current one that has its roots in reckless lending for the US housing market, are more difficult to shake because they are often held back by weak demand.
Worse still is that today’s recession combines a financial crisis at the heart of the United States, the world’s largest economy, with a broader global downturn making it unique, the Fund added.
“The analysis suggested that the combination of financial crisis and a globally synchronized downturn is likely to result in an unusually severe and long lasting recession,” the IMF said in chapters of its World Economic Outlook, which is to be released in full on 22 April.
It said counter-cyclical policies can help shorten recessions but its impact is limited in the presence of a financial crisis.
Fiscal stimulus can be particularly effective in shortening the life of a recession though not appropriate for countries with high debt levels, it added.
In its most recent forecast, the IMF said the world economy will shrink in 2009 by between 0.5% and 1.0%, the largest contraction since the Great Depression.
With advanced economies all in recession and growth in emerging market economies slowing abruptly, the IMF has urged countries to move quickly to clean up their financial sectors, in particular remove toxic assets from bank balance sheets, which would allow the economy to mend.
The IMF said dealing with the current global recession will require coordinated monetary, fiscal and financial policies.
In the short term, aggressive monetary and fiscal policy measures are needed to support demand.
Still, the IMF said restoring confidence in the financial sector was vital for economic policies to be effective and for recovery to take hold.
Emerging market stress
Turning to emerging economies, the IMF said the current level of financial stress in emerging market countries has already hit peaks seen during the 1997-98 crisis.
It said abrupt slowdowns in capital inflows have typically had dire consequences in these countries. The extent of the spillover from advanced to emerging economies is related to how closely their financial sectors are linked.
Using a new financial stress index, the IMF said current stress levels in advanced economies suggest capital flows to emerging economies, especially flows related to banking, will decline sharply and will recover slowly.
The latest reading from February 2009 shows that the steepest decline -- an annual contraction of 17.6% -- was recorded in central and eastern Europe, the region hardest hit by the crisis.
Even countries with lower current account and fiscal deficits, and higher foreign reserves, cannot escape financial the spillover from advanced economies, the IMF said.
However, as a recovery takes hold, those with smaller current account and fiscal deficits can make a quicker comeback than those with bigger deficits, it added.