The IMF warned of an even worse outcome if Europe can't defuse its debt crisis. It said global growth could drop 2 percentage points if Europe's problems escalate.
"Things have quieted down ... but an uneasy calm remains," said Olivier Blanchard, the IMF's chief economist. "One has the feeling that any moment, things could well get very bad again."
Europe's overall economy is expected to shrink 0.3 percent this year, according to the IMF forecast, before growing an anemic 0.9 percent next year.
Still, sharp differences divide the nations. Thanks to exports of cars and machinery to the United States and Asia, for example, Germany's economy is picking up. Low unemployment (5.7 percent) has given Germans money to spend.
By contrast, output in Spain and Italy is slumping as their governments cut spending to ease debt loads. Three smaller nations — Greece, Ireland and Portugal — are worse off. They're able to pay their debts only because they received bailout loans.
The most effective way for them to shrink their debts is to grow faster. But the usual tools to fuel production and hiring — cutting interest rates and boosting spending — are unlikely. The European Central Bank won't cut rates from their record low of 1 percent. Inflation is 2.7 percent, above the central bank's goal of just under 2 percent. Rate cuts might help revive weak economies by making borrowing cheaper. But they could also ignite inflation.
In the meantime, governments are being caught between the need to cut deficits and the need to grow. The 17 nations that use the euro have backed a treaty that limits their budget deficits. Analysts say that the push for austerity has led to slower output and higher unemployment in the most struggling countries.
Italy's economy is expected to shrink 1.9 percent this year, according to the IMF's forecast. Spain's economy shrank 0.3 percent in the fourth quarter. Spain's unemployment rate is 23.6 percent. For those under 25, it's 50 percent.
Spain's latest austerity budget lops €27 billion ($35 billion) off spending this year and raises corporate taxes. Pay for civil servants is frozen. Government departments must cut spending by an average 17 percent.
Governments likely have to improve their financial health to persuade bond investors to lend enough to roll over debt loads. Otherwise, high interest rates could force governments to seek bailouts to avoid disastrous defaults.
Greece, Portugal and Ireland have already needed such bailouts. Some fear Spain could be next. Italy is considered too big to rescue.
Spanish bond rates topped 6 percent this week, raising fears that they might near the 7 percent level that's forced some countries to receive bailouts.
The three bailed-out countries are still suffering. Greece must make deep cuts under the terms of its bailout loans. Yet it's in the fifth year of a severe recession, with 21 percent unemployment.
AP Business Writer David McHugh contributed to this report from Frankfurt, Germany.
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