The current global recession is likely to be unusually long and severe and the recovery sluggish since it sprang from a financial crisis, the International Monetary Fund said on Thursday.
The IMF called for aggressive and coordinated monetary and fiscal policies, and said restoring confidence in the financial sector was important for economic policies to work and for a recovery to take hold.
New IMF analysis published on Thursday shows recessions tied to financial crises, such as the current one which has its roots in reckless bank lending to the U.S. housing market, are more difficult to shake because they are often held back by weak demand.
Worse still is that the current global recession combines a financial crisis at the heart of the world's largest economy with a broader global downturn, making it unique, the IMF said in chapters of its World Economic Outlook, which is to be released in full on April 22 with updated forecasts.
The fund's analysis also says that emerging market economies, including those with sound economic policies, are not insulated from recessions beginning in major economies since they are often accompanied by a drop in exports and capital flows.
Using a new financial stress index, the IMF said stress levels in advanced economies suggest capital flows to emerging economies will suffer large declines -- especially banking-related flows -- and will recover slowly.
WHERE WILL RECOVERY START?
Stephen Danninger, a senior economist in the IMF's research department, said a global recovery was not likely without a pickup in advanced economies.
Clearly, given that capital flows are an important ingredient for emerging economies, it is most likely going to be the case that the recovery will not be possible without a recovery first taking place in advanced economies, Danninger noted.
Looking at past recessions, the IMF said there have been three episodes since 1960 during which 10 or more of the 21 advanced economies studied were in recession at the same time -- in 1975, 1980 and 1992.
A standard recession not tied to a financial crisis usually persists for about a year followed by a recovery that often lasts more than five years.
But the IMF said recessions similar to the current one last, on average, nearly 1.5 times longer, while recoveries are slow due to weak external demand, especially if the United States is also in recession.
Based on past experience, recessions associated with financial crises last almost two years, said Marco Terrones, deputy division chief in the IMF's research department, adding that every recession was different.
He said historical data showed a recovery from recession after a financial crisis takes almost three-and-a-half years before an economy reaches previous peak levels.
The IMF said counter-cyclical policies can help shorten recessions, but its impact is limited during a financial crisis, the IMF said.
As a result, fiscal stimulus can be more effective in shortening the life of a recession, but is not appropriate for countries with high debt levels, it added.
The analysis suggested that the combination of financial crisis and a globally synchronized downturn is likely to result in an unusually severe and long-lasting recession, the IMF said.
In its last forecast, the IMF said the world economy will shrink by 0.5 percent to 1.0 percent in 2009, the largest contraction since the Great Depression.
With advanced economies all in recession and growth in emerging market economies slowing abruptly, the IMF has urged countries to move quickly to clean up their financial sectors, and in particular, remove toxic assets from bank balance sheets, which would allow the economy to mend.
Turning to emerging economies, the IMF said the current level of financial stress in emerging market countries has already hit peaks seen during the 1997-98 Asian crisis.
It also said abrupt slowdowns in capital inflows have typically had dire consequences in emerging economies with the extent of the spillover from advanced to emerging economies tied to how closely their financial sectors are linked.