IMF chief Economist discussed the state of the global economy on chapters 1 and 2 of the IMF’s World Economic Outlook. With him at the briefing is Mr. Blanchard, Economic Counselor and Director of the Research Department, Mr. Decressin, Senior Advisor in the Research Department, and the world economic studies team management, Ms. Brooks and Ms. Duttagupta.

As the Managing Director said last week, the global economy has entered a dangerous new phase. The recovery has weakened considerably, and downside risks have increased sharply. Strong policies are needed both to improve the outlook and to reduce the risks.

Growth, which had been strong in 2010, decreased in 2011. We had forecast some slowdown due mainly to fiscal consolidation. One time events such as the tragic earthquake in Japan offered further plausible explanations for a further slowdown, and the initial data, at least from the U.S., initially understated the size of the slowdown. But, now that the numbers are in, it is clear that more was going on.

What was going on was the stalling of the two rebalancing acts, which as we have argued in many previous reports, are needed to deliver what the G-20 calls strong, balanced, and sustainable growth.

So, let me just talk a bit about each one, internal rebalancing and external rebalancing. So, rebalancing.
What is needed to sustain growth is that households and firms increase their demand as fiscal deficits are being rolled back. And, what we observe is that this is not going well for various reasons, most of them having to do with bad balance sheets, in effect.

Tight bank lending, the legacy of the housing boom, high leverage for many households all turn out to be putting stronger brakes on the recovery than we had anticipated.

Now, let me turn to external rebalancing, again, an old theme of these previous conferences. If domestic demand is going to be low in advanced countries, then those countries with current account deficits—and here we have in mind mainly the U.S.— need to compensate for it through higher foreign demand, that is the only way to sustain growth.

This in turn requires corresponding shifts away from foreign demand toward domestic demand in emerging markets countries with current account surpluses and here we have in mind mainly China.
Now, this rebalancing act is not taking place.

While imbalances narrowed in the crisis, this was due more to cyclical factors than to a structural adjustment of these economies. If we look forward, our forecast is for an increase rather than a decrease of imbalances.
By themselves these developments would have led us to reduce our forecasts, but the problems have been compounded by second major developments, a sharp increase in financial volatility since the middle of the summer.

What has happened is that markets have become more skeptical about the ability of policy makers of governments to stabilize their public debt. Worries have spread from countries at the periphery of Europe, to countries in the core of Europe, and then to others. Japan, even the United States.

Worries about sovereigns have translated into worries about the banks holding these sovereign bonds, mainly in Europe, and these worries have led to a partial freeze of financial relations with banks keeping high levels of liquidity and tightening lending.

Fear of the unknown is very high. Stock prices have fallen. This will adversely affect spending and growth in the months to come.

These developments have, not surprisingly, led us to revise our forecasts down. We now forecast world growth to be about 4 percent in 2011 and also 4 percent in 2012. This is down from 4.5 percent for both years in our April forecast. Now, 4 percent may not sound too bad, but, again, the recovery is very unbalanced.

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.

As usual, but probably bears repeating here, the forecast assumes that existing policy commitments are met. Otherwise, things could be much worse. Low growth, fiscal and financial weaknesses can easily feed on each other. Lower growth makes fiscal consolidation harder, and fiscal consolidation may lead to lower growth.

Lower growth weakens banks, and weaker banks lead to tighter bank lending and lower growth. In short, there are clear downside risks to the forecast that I have given you.

Let me say a word about emerging and developing economies. They’re not at the center of the action at this point, but they are clearly affected by it. So far, they have been largely immune to these adverse developments. They have had to deal with volatile capital flows, but in general have continued to sustain high growth.

Looking forward, however, they may well face the more difficult environment with more adverse export conditions, and even more volatile capital flows.

Let me turn to policy. In light of the low baseline, our low forecast, and the high risks, strong policy action is of the essence. It has to rely on three legs: The first leg is fiscal policy. Fiscal consolidation cannot be too fast, as it would kill growth. It cannot be too slow, as it would kill credibility.

The speed must vary across countries, the key continues to be credible, medium-term consolidation. Going beyond fiscal policy, measures which prompt domestic demand, which we explained is quite weak, ranging from continued low interest rates, to increased bank lending, to resolution programs for the housing market, are also of the essence.

This was the first leg.

The second leg is financial measures. Fiscal uncertainty will not go away over night. Even under the most optimistic assumptions, growth in advanced countries will remain low for sometime. During that time, banks must be made stronger. Not only to increase bank lending, which is essential to the recovery, but also to reduce the risks of vicious feedback loops.

The ones I’ve described. For a number of banks, especially in Europe, this requires additional capital buffers, preferably from private sources but if needed from public sources as well.

Let me turn to the third and last leg, which is external rebalancing.

It is hard to see how even with the policy measures listed above U.S. domestic demand can by itself ensure sufficient U.S. growth. Thus, the U.S. must rely more on foreign demand, in other words reduce its current account deficit. Looking at the other side of the world, the number of Asian countries with large current account surpluses, in particular China, have announced plans to rebalance from foreign demand toward domestic demand.

These plans clearly cannot be implemented over night, but they must be implemented as fast as can be.

Let me conclude. Only if governments move decisively on fiscal policy, financial repairs, and external rebalancing can we hope for a stronger and more robust recovery. Thank you very much.