Executive Summary

Global Economy is in Deepest Recession in Decades

The heady days of 2004-2007, when global GDP growth averaged about five percent per annum, seem like a distant memory now. Growth in most countries slowed in the first half of 2008 due in part to monetary tightening, the unprecedented rise in energy prices and dislocations in credit markets. However, global economic activity went into freefall in the fourth quarter of 2008 as credit markets froze up in the wake of Lehman Brothers failure, and the sharp downturn in major economies has extended into this year. Industrial production in the OECD countries (i.e., the thirty most developed economies in the world) plunged 17 percent in February, by far the sharpest year-over-year rate of contraction since records began in 1975.

We forecast global GDP will decline one percent this year. Although our projection may not sound bad, global GDP has never contracted, at least not since the International Monetary Fund (IMF) began calculating the series in 1970. The G-7 countries are in the midst of their worst recessions in decades. Developing economies are hardly immune to the sharp reduction in global trade that has transpired, and a sharp slowdown has occurred in the emerging world. Developing economies that had over-leveraged financial sectors have been especially hard hit, and countries such as Belarus, Hungary, Iceland, Latvia, Pakistan and Ukraine have already gone to the IMF with hat in hand.

Not only has the IMF been very busy since last autumn, but national governments have also been hard at work in responding to the crisis. First, governments have taken steps to shore up their respective financial systems via recapitalization, loan guarantees, and increased deposit insurance. Although the global financial system is hardly back to normal, some segments of the credit markets are starting to function again. In addition, most central banks have cut policy interest rates to unprecedented levels, and national governments have enacted fiscal stimulus programs of varying sizes.

There are tentative signs that the efforts of policymakers are starting to bear some fruit. Data from the second quarter is rather limited at this point but it appears that most major economies continue to contract, albeit at rates that are much slower than over the past two quarters. In addition, there have been some bona fide green shoots of recovery spotted in some major developing economies. The manufacturing PMI in China has moved above the demarcation line that separates expansion from contraction, and industrial production in Brazil, Korea and Taiwan are well off the lows that were set early this year. Although it would be premature to state that the overall global economy has stabilized, we probably are at or near an inflection point where the rate of decline starts to slow. By the end of the year, global economic activity should be growing again on a sequential basis.

Global growth should be stronger in 2010 than in 2009, but it will probably fall short of its long-run average of 3.7 percent per annum. Thus, the global upturn that we are expecting will probably be sluggish, at least initially. The eventual U.S. recovery probably will be held back by slow growth in consumer spending as individuals attempt to de-lever and repair battered balance sheets. Policy response in Europe and Japan have generally been less aggressive than in the United States, so both the Euro-zone and Japan are probably looking at a slow recoveries as well.