IMF: As Recession Worsens, World Economy Will Shrink This Year

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The financial crisis erupted in the United States in August 2007 and spread around the globe. The crisis entered a tumultuous new phase last fall, shaking confidence in global financial institutions and markets. Total worldwide losses from the financial crisis from 2007 to 2010 could reach nearly $4.1 trillion, the IMF estimated in a separate report Tuesday.

The crisis has led to bank failures, wiped out Lehman Brothers and forced other big institutions, like insurance giant American International Group, to be bailed out by U.S. taxpayers.

And it's triggered radical government interventions — such as the United States' $700 billion financial bailout program and the Federal Reserve's $1.2 trillion effort to lower interest rates and spur spending.

Actions by the United States and government in other countries have helped ease the crisis in some ways. But markets are still not operating normally.

The 185-nation IMF, headquartered in Washington, is the globe's economic rescue squad, providing emergency loans to countries facing financial troubles. It has urged countries to take bolder actions to bolster banks.

The IMF also has pushed countries to work more closely together. It favors coordinating fiscal stimulus efforts through tax reductions or greater government spending to stimulate the appetites of consumers and businesses. And it warned countries to resist the temptation of enacting protectionist trade measures.

"Fiscal policies had made a gigantic difference," said IMF Chief Economist Olivier Blanchard. Without them, the hit to the global economy would have been much greater and pushed it perilously close to "a depression," he added.

Because the world economy won't be back to normal next year or perhaps even in 2011, Blanchard urged countries to spend money on big public works projects — something the Obama administration is doing — to bolster activity.

Bold policy actions could set off a mutually reinforcing "relief rally" in financial markets and a revival in consumer and business confidence, the IMF said in its report. But it remains concerned that these policies won't be enough to break the vicious cycle whereby deteriorating financial institutions feed, in turn, weaker economic conditions.

"The problem is that the longer the downturn continues to deepen, the slimmer the chances that such a strong rebound will occur, as pessimism about the outlook becomes entrenched and balance sheets are damaged further," the IMF said in the report Wednesday.

With the global economy stuck in a recession, the risks of a dangerous bout of deflation — a prolonged decline in prices that can worsen the economy — has risen. The IMF cited a "moderate" risk of deflation in the United States and in the 16 countries that use the euro. It saw a "significant likelihood of deeper price deflation" in Japan.