The global economy has turned the corner from the great recession. However, securing the transition from recovery to expansion will require a concerted effort at addressing diverse challenges, according to IMF.
The key fiscal priority for major advanced economies, especially the United States and Japan, is to implement credible and well-paced consolidation programmes focused on bolstering medium-term debt sustainability. Given the tepid recoveries in these economies thus far, consolidation should ideally be gradual and sustained so as not to undermine growth prospects.
For the United States, it is critical to immediately address the debt ceiling and launch a deficit reduction plan that includes entitlement reform and revenue-raising tax reform. Should the recovery threaten to turn out substantially weaker than currently projected, the pace of fiscal adjustment should be modified accordingly, within the envelope of a credible medium-term consolidation plan. Similarly, Japan needs to make progress in tax and entitlement reforms to alleviate its worrisome debt dynamics.
Advanced economies must also address the financial sector vulnerabilities that were at the root of the crisis. In this regard, the situation is more critical in various European economies than elsewhere. In the euro area periphery, there is no way around ambitious structural reforms to boost competitiveness and revive employment growth, along with front-loaded fiscal adjustment and balance sheet repair to restore market confidence and ameliorate the pressure on sovereign and bank spreads. These efforts need to be flanked with concrete steps to strengthen EU-wide supervision and crisis resolution, including by making the safety net more flexible.
In advanced economies with still-sizable economic slack and continued drag from fiscal and financial sector consolidation, monetary policy should stay accommodative; this includes the United States, Japan, and the euro area. As the recovery proceeds and economic slack diminishes more broadly, however, central banks must guard against further increases in core inflation. Importantly, accommodative monetary policy cannot become a substitute for insufficient financial sector repair. In the meantime, macro-prudential policies and stronger financial supervision can help contain risks flowing from a prolonged period of low interest rates.
In a number of emerging and developing economies that are already operating at or above pre-crisis levels of output, the priority is to expeditiously tighten macroeconomic policies, and use exchange rate flexibility and macro-prudential tools, possibly including capital controls, to help contain risks of boom-bust cycles. While many emerging and developing economies are already raising policy rates, real rates still remain low. Thus, policy tightening must continue, coordinated with transparent central bank communication to anchor inflation expectations.
Economies with high fiscal deficits or debt also need to rebuild room for fiscal policy maneuver, especially those that are susceptible to external shocks or have sharply widening current account deficits, or currencies approaching overvaluation ranges. At the same time, social sector spending and priority infrastructure investment must be preserved. For economies with excessive current account surpluses, particularly in Asia, demand rebalancing, through exchange rate appreciation and structural reforms, remains a top priority for securing balanced growth and employment gains in the medium term.