Global Economy 2009

It was never meant to happen again, but the world economy is now mired in the most
severe fi nancial crisis since the Great Depression. In little over a year, the mid-2007 subprime
mortgage debacle in the United States of America has developed into a global fi nancial
crisis and started to move the global economy into a recession.

Aggressive monetarypolicy action in the United States and massive liquidity injections by the central banksof the major developed countries were unable to avert this crisis. Several major fi nancialinstitutions in the United States and Europe have failed, and stock market and commodityprices have collapsed and become highly volatile. Interbank lending in most developedcountries has come to a virtual standstill, and the spread between the interest rate on interbankloans and treasury bills has surged to the highest level in decades. Retail businesses
and industrial fi rms, both large and small, are fi nding it increasingly diffi cult to obtain
credit as banks have become reluctant to lend, even to long-time customers. In October
2008, the fi nancial crisis escalated further with sharp falls on stock markets in both developed
and emerging economies. Many countries experienced their worst ever weekly sell
off in equity markets.

Since early October, policymakers in the developed countries have come up
with a number of more credible and internationally concerted emergency plans. Compared
with the earlier piecemeal approach, which had failed to prevent the crisis from
spreading, the latest plans are more comprehensive and better coordinated. Th e measures
have reshaped the previously deregulated fi nancial landscape; massive public funding was
made available to recapitalize banks, with the Government taking partial or full ownership
of failed fi nancial institutions and providing blanket guarantees on bank deposits
and other fi nancial assets in order to restore confi dence in fi nancial markets and stave
off complete systemic failure. Governments in both developed and developing countries
have started to put together fi scal and monetary stimulus packages in order to prevent the
global fi nancial crisis from turning into another Great Depression.

Will this work? It is hard to predict, but doing nothing would almost certainly
have further aggravated the downside risks and more likely than not pushed the world
economy into a deeper crisis. It should be appreciated, however, that it will take time for
most of these policy measures to take eff ect; the restoring of confi dence among fi nancial
market agents and normalization of credit supplies will take months, if not years, if past
crises can be seen as a guide. Furthermore, it typically takes some time before problems
in fi nancial markets are felt in the real economy. Consequently, it seems inevitable that
the major economies will see signifi cant economic contraction in the immediate period
ahead and that recovery may not materialize any time soon, even if the bailout and stimulus
packages succeed. Moreover, the immediate fi scal costs of the emergency measures
will be huge, and it is uncertain how much of these can eventually be recovered from
market agents or through economic recovery. This poses an additional macroeconomic
challenge.

Most developed economies entered into recession during the second half of
2008, and the economic slowdown has spread to developing countries and the economies
in transition. According to the United Nations baseline forecast, world gross product
(WGP) is expected to slow to a meager 1.0 per cent in 2009, a sharp deceleration from the
2.5 per cent growth estimated for 2008 and well below the more robust growth in previous
years (table I.1). Th e baseline forecast assumes that it will take six to nine months for
financial markets in developed countries to return to normalcy, assuming central banks in
the United States, Europe and Japan provide further monetary stimulus from the end of
2008 and on into 2009.

Uncertainties surrounding this forecast are high, as shown by the confidence
interval around the baseline forecast. In a more pessimistic scenario, both the
fire sale of financial assets and the credit crunch would last longer, while monetary stimulus
would prove ineffective in the short run and fiscal stimulus would turn out to be too
little, too late. This would then lead to worldwide recession in 2009, with global output
falling by 0.4 per cent, and postpone recovery to, at best, the following year. In a more optimistic
scenario, a large-scale fiscal stimulus coordinated among major economies would
stave off the worst of the crisis, yet—for the reasons indicated—it would not prevent a significant slowdown of the global economy in 2009.