World Crisis Online

The US fiscal stimulus package agreed late last year and the Federal Reserve’s autumn decision to restart quantitative easing have significantly improved the outlook for growth, according to the International Monetary Fund.

Increasing its forecast for US 2011 growth by 0.7 percentage points to 3 per cent, the fund credited the tax-cutting deal between President Barack Obama and the outgoing Congress, which also extended unemployment insurance.

But the new stimulus sows the seed of a longer-term crisis in the US public finances, the fund warned on the day the president will address the issue in his second State of the Union address to Congress.

The IMF’s updated projections for the global economy are generally optimistic with upward revisions to its 2011 growth forecasts for both advanced and emerging economies. The fund also said it is most likely that the eurozone will not succumb to a new crisis.

This rapid recovery, bringing world growth rates back to pre-crisis levels in every year between 2010 and 2012, will probably keep commodity prices high and stoke inflation in emerging economies.

“Near term risks are now to the upside for most commodity classes,” the IMF warned as it forecast that non-oil commodity prices would rise by 11 per cent in 2011.

The key message from the fund was that fiscal policy should be tightened in most countries. While it acknowledged that the US fiscal package is likely to boost growth, the report noted that “the recently implemented stimulus is expected to deliver only a relatively small growth dividend (given its size) at a considerable fiscal cost”.

It projected that gross US government debt would hit 110 per cent of national income by 2016, and that the deficit this year will be more than twice that of the eurozone.

“The absence of a credible, medium-term fiscal strategy would eventually drive up US interest rates, which could prove disruptive for global financial markets and for the world economy,” the IMF said.

In the more immediate future, the greatest risk to the global economy came from Europe, the fund noted. “Although the [European] periphery accounts for only a small portion of the euro area’s overall output and trade, substantial financial linkages… could generate a slowdown in growth and demand that would hinder the global recovery.”

The fund again criticised emerging economies, including China, for continuing to run trade surpluses at the same time as many are dampening exchange rate appreciation. ”The response to renewed capital inflows has been to accumulate even more foreign exchange reserves,” it said.

For these countries, the fund recommended allowing currencies to appreciate to “help combat overheating pressures and facilitate a healthy rebalancing from external to domestic demand”. When a country allows appreciation, the fund expressed openness to capital controls being used to discourage destabilising inflows of hot money, seeking short-term higher returns than in advanced economies.