Downside Risks to World Economic Growth Call for Concerted Policy Action
United Nations Department of Economic and Social Affairs
Date: June 9, 2007
The risk of a global economic slowdown In the World Economic Situation and Prospects 2007, the United Nations warns of a possible global economic downturn, with significant risks attached. The US housing market or the currency market is the most likely trigger of such a slowdown.
The net result is a two-pronged risk: slower growth in the US will be transmitted to the rest of the world, without any other major economy able to replace it as the main engine of global growth. The second and third largest economies, Japan and Germany, will need to urgently revive domestic demand (which they have failed to in the recent past). China, the fourth largest economy, is not yet large enough to compensate for a US slowdown, as its own export growth will be affected by slower US growth.
Another downside risk to global economic growth relates to investor sentiment about the US dollar. The US has built up net liabilities with the rest of the world expected to reach $4 trillion in 2007.
It is difficult to predict how much more of their asset portfolios foreigners will be willing to invest in the US, but only a small change in market sentiment and expectations of a dollar decline may trigger a massive withdrawal of dollar-denominated assets, precipitating strong downward pressure on the dollar. This, in turn, could have a destabilizing effect on financial markets.
It is unlikely that any one government will be prepared to bear the costs of policies needed to correct the imbalances on its own. But there is scope for an internationally coordinated set of macroeconomic policies which could help reduce the risk of weaker growth in the major economies, maintain confidence in the stability of international financial markets and avoid a hard landing of the dollar.
Exchange rates should be realigned in a coordinated fashion to stimulate exports from the deficit countries and import demand from the surplus countries. This is not just a matter of revaluing the Chinese currency, as argued by some US policy makers, but requires gradual adjustment of most major currencies against the dollar in conjunction with concerted fiscal and monetary policy management to strengthen demand in the rest of the world.
Such new arrangements should be used to work towards more structural reforms of the international monetary system, away from its currently excessive reliance on the US dollar as reserve currency. Such reforms should work towards the development of a multilaterally agreed multi-currency reserve system or even a world currency based on the Special Drawing Rights issued by the IMF in the longer term.
Prospects of weaker growth in the US and the world economy at large, and the possibility of an imminent hard landing for the dollar should be alarming enough to mobilize concerted action by policy makers.
Prepared by Rob Vos, Director, Development Policy and AnalysisDivision Department of Economic and Social Affairs, UnitedNations
The above information has been redacted from the UN-DESA Policy Brief No. 1 May 2007.
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