Changing Growth Trends Carry New Global Spillovers

With changing world environment, global spillovers enter a new phase

Advanced countries recovering, emerging markets see broad-based slowdown

Need for stronger policy actions at national and global levels

The 2014 Spillover Report, which assesses the impact of policy actions in one country on others (spillovers) and the possible consequences for the original spillover source economies themselves (spillbacks), analyzes the implications of two key trends.

First, interest rates are expected to rise as some major advanced economies begin to unwind their extraordinary stimulus as recovery takes hold. With policy rates near zero and large central bank balance sheets, these central banks face complex challenges in achieving a smooth unwinding, the IMF staff report says. Yet, with recovery uneven across countries—faster in the United States and the United Kingdom than in the euro area and Japan—normalization will be “asynchronous,” that is, proceed at different times. This has possible spillovers implications.

Second, emerging market economies are slowing in a synchronized and protracted manner, and average emerging market GDP growth is projected to decline from 7 percent during the pre-crisis period (2003-2008) to 5 percent over the next 5 years. This trend carries sizable spillovers to the rest of the world through trade and finance, and also has substantial influence on other emerging markets and developing economies through “neighborhood” effects.

These two risks could intersect and interact with each other, the report says. “Markets may reassess growth prospects in emerging markets if there are renewed bouts of financial turbulence as advanced economies normalize monetary policy,” noted Hamid Faruqee, chair of the task force producing the report. Such a reassessment by markets could, in turn, generate further stress, he added.

One of the downside scenarios, according to the report, is that tighter financial conditions combined with further weakening of emerging market growth could lower global output by as much as 2 percent.

Monetary unwinding in advanced economies

Not all spillovers are negative, says the IMF staff report, which stresses that the reason why financial conditions tighten plays a key role in determining the spillover effects.

When advanced economies normalize monetary policy as their economic outlook improves, interest rates (and thus global yields) will rise. While this will tend to tighten financial conditions across the...