With the fate of the euro up in the air, a protracted recovery underway in the United States, and strong but slowing growth in emerging markets, 2012 may well be another difficult year for the global economy. Carnegie hosted the American Enterprise Institute’s Desmond Lachman, the IMF’s Chief Economist Olivier Blanchard, and Carnegie’s Uri Dadush and Vikram Nehru to discuss the Fund’s latest economic forecasts and their significance for the eurozone, the United States, and emerging markets, notably China.

The Global Outlook

  • Updated Forecasts: Assuming a slow, but steady resolution of the euro crisis, the IMF forecasts a mild recession in Europe (-0.5 percent contraction), modest growth in the U.S. that does not significantly lower unemployment (1.8 percent), and slower, but still robust growth in developing economies and emerging markets (5.4 percent), said Blanchard.

  • Legacies of the Financial Crisis: Blanchard noted three trends in advanced countries that will be positive in the long run but are detrimental in the short run:

    • Households are saving more and deleveraging. Their balance sheets will be healthier, but it is not clear what will replace demand as consumers pull back.

    • Fiscal consolidation is taking place on the order of 1 percent across countries. This adjustment is needed, but in the short run it will discourage demand and growth.

    • The financial system is deleveraging, which could contribute to a credit crunch. Normally, adjustment would take place through a decline in the interest rate, which would stimulate demand, but this path is foreclosed given near-zero rates, Blanchard added.

  • Impact of the Euro Crisis: With the euro crisis contained so far, the United States has benefited from a “safe haven” effect, Blanchard said. He estimated that the euro crisis has decreased the U.S. loan rate by 1 percent. Central and Eastern Europe have suffered the brunt of eurozone deleveraging. The impact of the euro crisis on other emerging markets is more complicated, Blanchard added. On the one hand, investors have a smaller appetite for risk. On the other, they are attracted by the higher returns emerging markets offer. As long as Europe muddles through, capital will likely continue to flow to emerging markets.

  • Reasons for Optimism: Dadush noted that the volatility of current events makes it easy to overlook the fact that underlying drivers of prosperity—including the advance and spread of technology—have never been as strong as they are today. The world’s potential long-term growth rate is an unprecedented 3.5 percent at market exchange rates. Blanchard also noted the striking resilience of emerging markets, which have continued to grow despite the weak recovery and structural problems advanced countries face.

Future of the Eurozone

  • Two Scenarios: Blanchard observed that the eurozone will either continue to muddle through or will face deteriorating conditions. Muddling through to eventual resolution of the crisis may take longer than desirable, but is “well within reach,” he asserted.

  • Fiscal Consolidation: Lachman argued that fiscal consolidation in the eurozone periphery at a time of economic weakness is almost certainly a recipe for failure. Demand will fall and growth will shrink. The economies will thus raise less revenue and fail to meet their fiscal adjustment targets. A repeat—or many repeats—of Greece could be in store. Blanchard added that the time frame over which fiscal adjustment takes place is critical. In Chancellor Merkel’s words, “Fiscal consolidation is a marathon, not a sprint.”

  • Competitiveness: Dadush drew attention to the role of competitiveness in exacerbating the eurozone’s fiscal problems, noting that four of the five eurozone countries in trouble have large current account deficits and cannot turn to exports for growth. Blanchard pointed out that not all eurozone countries face both fiscal and competitiveness problems. Spain, for example, had a responsible fiscal policy but lost its competitiveness. Italy meanwhile does not have a current account problem, but has a high debt-to-GDP ratio.

  • Moving Forward: Blanchard argued that, for eurozone countries in the deepest trouble, three steps are needed: a dramatic reduction in debt; structural reforms that will help restore competitiveness; and, in the near-term, access to funding from official creditors. Lachman added that Germany needs to get away from the idea that across-the-board fiscal consolidation is appropriate. He argued that Greece, Ireland, and Portugal should leave the eurozone and write down their debt.

A Sustainable U.S. Recovery?

  • Risks: Dadush identified two major risks to the U.S. recovery: possible deterioration in the European situation and political gridlock, which could get even worse this year if the Senate changes hands.

  • Signs of Hope: The U.S. private sector, which accounts for about 80 percent of employment, has seen extraordinary productivity growth and has generally returned to being profitable, Dadush said. The housing sector is still depressed, but that is because it was overextended before the financial crisis. Growth is lower now because of weakness in the housing sector, but more sustainable. Blanchard noted that the Fed’s loose monetary policy sends the “right message.”


  • Strong Growth Drivers: It is easier for China to manage risks, including a downturn in the housing market and bad local government debt, because it has such an ample cushion in the form of a strong public sector balance sheet, $3 trillion in foreign reserves, and a nationalized banking sector, said Dadush. The IMF forecasts a soft landing of 8.2 percent this year.

  • Rebalancing: China’s current account surplus has dropped from 7-8 percent to about 3.5 percent, added Dadush. The big surpluses are now in Germany (6 percent), Sweden, Switzerland (13-14 percent), and the Netherlands.

  • Helping Europe: The Chinese are open to helping Europe, but not until they’re convinced that Europe has a good game plan for the future, said Dadush. Recipient countries must have a plan in place for making fundamental reforms to ensure their solvency, Lachman said.