G R O U P of T W E N T Y

G-20 Toronto Summit
Toronto, Canada, June 26-27, 2010

G-20 Mutual Assessment Process—Alternative Policy Scenarios

Prepared by Staff of the International Monetary FundI N T E R N A T I O N A L

M O N E T A R Y

F U N D

G-20 Mutual Assessment Process—Alternative Policy Scenarios
A Report by the IMF Staff
Executive Summary
This report provides Fund staff’s analysis of alternative policy scenarios to achieve strong,sustainable and balanced growth based on G-20 frameworks submitted for the Mutual
Assessment Process (MAP). After establishing a baseline scenario on the basis of G-20
submissions and key economic and financial developments thereafter, Fund staff, guided by the
G-20, developed two alternative scenarios—an upside and a downside case—to explore thepotential benefits of further G-20 policy action to help deliver on their shared objectives ofstrong, sustainable and balanced growth. Key findings are as follows.
Collective action would yield tangible and material benefit to the G-20 membership andthe global economy. An upside scenario of collaborative policy actions would credibly
strengthen outcomes and address key weaknesses in G-20 policy frameworks. Specifically:Global growth would be appreciably stronger—reducing poverty worldwide. Global GDP
would be higher relative to the G-20 baseline by 2½ percent over the medium term (i.e.,
after 5 years). World output would be higher by over 1½ trillion U.S. dollars.



Employment gains would be significant across regions. An estimated 8 million more jobs
would be created in advanced economies, over 21 million in emerging Asia and rest of theworld, and global employment would rise by around 30 million jobs.

This would lift an estimated 33 million people out of poverty, according to a companion
World Bank Report.

Global growth would also be more balanced and thus more sustainable under collective
action. In the upside scenario, stronger domestic demand in surplus countries is matched with
deficit economies rebuilding saving on the back of stronger external demand. Accordingly,
greater rebalancing of demand would be achieved, and external imbalances would narrowappreciably. Specifically:Driven by strong and credible consolidation, public finances would be returned onto asustainable trajectory in G-20 advanced economies. Credible consolidation plans—designed
to be “growth friendly”—would mitigate the dampening effect on domestic demand.
Monetary policy accommodation could be maintained for a more extended period to help
support activity, since inflation would remain contained as fiscal balances are strengthened.



Alongside fiscal consolidation in the advanced economies, the case for complementaryaction is strong across G-20 partners. To avoid a global “demand deficit” and slower
growth, key structural reforms to boost internal demand in emerging economies with large
external surpluses would help them avoid a domestic slowdown and to play a leading role insupporting global growth.

Exchange rate adjustment is shown to be an integral component of global rebalancing.
Overall, global imbalances (sum of absolute current account positions) narrow by one
quarter or ¾ percentage points of global GDP.

Collective action would also help mitigate risk—reducing prospects of a downside scenariothat could inflict heavy costs. The G-20 “base case” is subject to significant downside risks—particularly, fiscal risks and lower productivity.


A scenario where these risks materialize suggests that global output could be lower by morethan 3 percent (about 2¼ trillion U.S. dollars) over the medium term relative to the refinedbaseline; around 23 million jobs could be lost, while nearly 60 million people could fall intopoverty. Reactive policies in the downside scenario are shown to be less effective.



Importantly, many of the key policies in the upside would help reduce the risks associatedwith the downside, reinforcing the case for these collaborative actions. Upside gains andavoidance of downside losses would sum to much larger benefits.

To advance progress toward meeting G-20 objectives of strong, sustainable and balanced
growth, policies should be prioritized and tailored to the requirements and conditions ofindividual members. In accordance with G-20 guidelines, this report indicates key policy
actions for broader G-20 groups of countries with similar circumstances:

Credible fiscal consolidation over the medium term, underpinned by high-quality measuresof sufficient magnitude, should be a top priority in advanced deficit economies given
sovereign debt market stress and other fiscal risks. Substantial budgetary effort would be
required to restore fiscal soundness and to rebuild market confidence. In this regard,
credible and coherent fiscal plans should be clearly communicated as soon as possible.

To reduce regulatory uncertainty, advanced economies should also accelerate financial
repair and reform. Long-awaited progress here is essential to rebuild a well-functioning
financial system to provide credit and support growth, while safeguarding financial stability.

Product and labor market reforms are important in advanced surplus economies,
particularly in countries hardest hit by the crisis, to repair possibly lower supply potential
and reduce persistently high unemployment. Reforms should be friendly to demand, as wellas supply.

In emerging surplus economies, policy should aim at enhancing social safety nets,
reforming corporate governance, and developing financial markets, supported by greater
exchange rate flexibility to facilitate a rebalancing of demand towards domestic sources.
This would avoid a slowdown in growth, given softer external demand. Greater
infrastructure spending, including in major oil exporters, could further address supply
bottlenecks in many of these fast-growing economies.

In emerging deficit economies, policies should focus on simplifying product market
regulation, improving infrastructure, and increasing efficiency of the formal sector tostrengthen growth and employment.

G-20 Mutual Assessment Process (MAP)—Alternative Policy Scenarios
A Report by the IMF Staff1
I. INTRODUCTION
1.
Fund staff assessment of macroeconomic and policy frameworks submitted by
G-20 members identified several economic and policy issues and key risks. The
assessment found that the G-20 “base case” projections, at face value, appear to deliver
strong, sustainable and balanced growth. However, when compared with historical evidence
relating to recovery from crises and staff’s analysis in the World Economic Outlook (WEO),
growth projections appeared optimistic. Moreover, even assuming that the “base case”
scenario materialized, the analysis identified some key weaknesses. In particular, fiscal
consolidation was assessed to be insufficient to decisively address sustainability issues in a
number of advanced economies. Also, rebalancing of global demand was viewed as not
being strong enough to sustain high global growth and achieve low unemployment. Finally, it
was assessed that stronger efforts to repair and reform the financial system was needed tosupport G-20 growth objectives, while safeguarding financial stability.
2.
Based on the findings of this assessment, the G-20 asked Fund staff to explore
two alternative scenarios to develop a set of policy actions that would help achieve theirshared objectives. First, an upside scenario “...and associated policy requirements, thatwould accelerate the progress towards achieving stronger, more sustainable and balanced
growth, in the areas where this is not achieved in the base case.” Second, a downside
scenario “... that identifies downside risks to the base case scenario and identifies the policies
needed to avoid them.”
3.
In response to the G-20’s request, this note provides an analysis of alternative
scenarios to consider the options for further policy action. The note is structured asfollows. To provide a sensible starting point for the scenario analysis, Section II summarizes
staff’s refinement of the “base case” projections to ensure greater multilateral consistency
and to reflect recent economic and market developments. This section also summarizes themodeling framework used for the scenarios. Building on the refined baseline, Section III
presents an “upside” policy scenario, illustrating the benefits of collective action. Section IV
discusses a “downside” scenario and the effectiveness of reactive policies. Section V
summarizes the potential benefits of moving across the two scenarios and indentifies key
policy priorities that would help G-20 members achieve their shared objectives for strong,sustainable and balanced growth.
II. REFINING THE G-20 MAP BASE CASE AND THE MODELING FRAMEWORK
4.
To better anchor the scenario analysis, refinements were made to the G-20 “basecase” to ensure greater consistency and to reflect recent economic and market
developments. These refinements are technical in nature and do not reflect further staff
1

Prepared by staff of the Research Department of the International Monetary Fund. Analysis of structuralreform priorities and scenarios was done in collaboration with OECD staff and has also benefited from ILO
inputs.

judgment on the effectiveness of G-20 policies assumed in the baseline. Revisions to the G20 MAP “base case” are necessary for two reasons—to achieve greater multilateralconsistency and to reflect recent developments (see Box 1 for details).
First, G-20 macroeconomic frameworks exhibit significant differences with respect to thelikely output losses following the financial crisis. In particular, the major G-20 advanced
economies that experienced a banking crisis project a fairly rapid recovery, under which
they recoup most of their crisis-related output losses, while others project a more gradual
recovery. Implicitly, the former countries see large output gaps, while the latter do not.
Accordingly, staff used a model-based econometric framework to estimate a consistent
set of output gaps and to adjust the “base case” as needed.

Second, submissions by individual G-20 members differed by vintage, with someproviding input as early as end-January and others as late as end-March 2010. Since then,important events in financial markets and significant economic developments haveoccurred. Thus, the “base case” was updated to also reflect recent economic and market
developments.

5.
From this refined baseline, alternative scenarios are developed using the IMF’s
Global Integrated Monetary and Fiscal (GIMF) model. As with any modeling framework,
the analysis of policies and their effects is stylized and indicative. The simulation results are
subject to uncertainty. Nonetheless, it is a useful tool to analyze and illustrate the benefits ofalternative policy options within a rigorous and consistent analytical structure for the global
economy. Given the model’s structure, the stylized simulations are applied to each country or
region. In accordance with G-20 guidelines, the policy assessments from the scenarios arethen mapped into the broader groupings of G-20 members with similar economic
circumstances and policy needs.2 More specifically:

The model contains 5 stylized countries or regions—the United States, euro area, Japan,
emerging Asia, and rest of the world (ROW). The simulations are based on these entities
or blocks.

To help differentiate key fiscal and structural policy challenges facing euro area surplus
versus euro area deficit countries, the model was extended to distinguish between
Germany and other euro area members. For the purpose of monetary policy andexchange rate analysis, however, the euro area is naturally treated as a single unit—
featuring a common monetary policy and single currency.

Throughout the scenario analysis, nominal exchange rates are assumed to adjust flexibly
between the regions (except, of course, between Germany and the rest of the euro area).

2

Thematic G-20 groupings are: advanced surplus countries (Canada, France, Germany, Japan, Korea, and theNetherlands); advanced deficit countries (Australia, United Kingdom, and United States, and the euro area
minus France, Germany, and the Netherlands); emerging surplus countries (Argentina, China, and Indonesia);
emerging deficit countries (Brazil, India, Mexico, South Africa, Turkey, and other EU countries); and major oil
exporters (Russia and Saudi Arabia).



The model simulation results are translated into policy implications for broader groups by
mapping the particular model block to the respective G-20 thematic grouping with similar
economic circumstances and policy challenges.
III. UPSIDE SCENARIO—BENEFITS OF COLLECTIVE ACTION

While policy priorities and measures should be tailored to each individual country’s
economic situation and policy needs, the scenario analysis presented here is “stylized”—
applying to groups of countries with similar circumstances. In accordance with G-20
guidelines, the report explores key policy actions only for these broader groups. Thus, thesimulation results should be interpreted as “indicative.”
6.
The upside scenario explores policies that could credibly deliver G-20 objectivesof strong, sustainable and balanced growth. The set of polices examined here—specified
for G-20 groupings of member countries—go beyond what is assumed in G-20 policy
frameworks. The analysis is used to explore the benefits of collective action in two key
dimensions. First, the scenario explores the extent to which a set of strengthened G-20 policy
actions could provide a sounder basis for desired G-20 outcomes. Second, the upside
scenario explores further policy options to address key weaknesses in the G-20 base case,such as persistently high unemployment and possibly lower potential output.
7.
The set of policy options that could strengthen G-20 outcomes would require
collaborative action across the membership. The major policy actions considered acrossthe G-20 include: (i) “growth-friendly” fiscal consolidation in advanced economies;(ii) structural reforms (including strengthening social safety nets) and sustained infrastructure
spending in emerging surplus economies, accompanied by increased exchange rate
flexibility; and (iii) structural reforms in advanced economies to tackle high unemployment
and weaker potential output following the crisis. These policy “layers” can be motivated asfollows.
There is a pressing need, in general, for fiscal consolidation in G-20 advanced
economies. In the “base case,” fiscal deficits and debt levels in advanced economies areprojected to remain large, notwithstanding favorable macroeconomic outcomes. This
could weigh on the recovery and further raise market pressure in an environment ofelevated uncertainty about sovereign debt risks. Thus, elements of alternative policy
scenarios should consider fiscal consolidation, notably in economies with large fiscal andexternal deficits. Consolidation plans should be strong, credible, and, to the extent
possible, supportive of growth. This would seem to require a sufficient scale ofadjustment, more efficient redistribution of the tax burden and allocation of spending, as
well as clear and effective communication of credible and coherent fiscal consolidation
strategies.



The second layer involves complementary action in emerging economies, particularly
those with large external surpluses, to support global demand. Policies that areconsidered aim to strengthen social safety nets and minimize economic distortions to
reduce high precautionary saving, increase infrastructure spending, and to allow greater
exchange rate flexibility to facilitate the shift to domestic demand. Higher internal
demand in surplus economies would support growth both domestically and globally,helping to offset the global “demand deficit” stemming from fiscal restraint in advanced
economies.
The third layer addresses supply constraints on G-20 growth, particularly in advanced
economies hardest hit by the crisis. Potential output growth may be low in largeadvanced countries and could be increased to maintain relatively high living standards.
Importantly, structural reform may need to be accelerated in key areas to repair damaged
potential and to reduce high unemployment. Such policies should focus on reforming
labor, product, and services markets in key areas to increase productivity and lower
unemployment. Policies should also be mindful of ways to sufficiently strengthen
demand, alongside supply, to avoid building excess capacity. Finally, while not explicitly
modeled, financial system regulatory reform and repair of financial intermediation would
be crucial to support stronger economic growth over the medium term.
A. FISCAL CONSOLIDATION TO RESTORE SUSTAINABILITY IN ADVANCED ECONOMIES

8.
In the upside scenario, fiscal adjustment is underpinned, to the extent possible,
by sound and “growth-friendly” policies, underscoring the role of credibility. To restore
sustainability of public finances, while mitigating the impact on growth, three core elementsof fiscal consolidation would be instrumental: (i) sufficient scale to improve primary fiscal
balances to stabilize public debt at prudent levels, given growth and interest rates;(ii) growth-friendly composition of fiscal measures to mitigate the dampening effect on
demand, including through entitlement reform; and (iii) strengthened credibility of fiscal
plans, including through clear and effective communication to market participants, to alignmarket expectations with the authorities’ medium-term consolidation strategy. Key aspects ofeach component are elaborated below.
9.
To stabilize public debt at prudent levels, the scale of fiscal adjustment would
need to be sufficiently strong, accounting for country-specific needs. Major fiscal
consolidation is needed in the years ahead in G-20 economies with high public deficits anddebt.3 Different economic circumstances and policy needs across advanced economies would
determine the timing, magnitude, and composition of consolidation at the individual country
level. Reducing public debt to more prudent (e.g., pre-crisis) levels over the medium term isdesirable for several reasons, including: (i) a need to rebuild fiscal space to deal with future
shocks; (ii) possibly higher interest rates and lower potential growth given high public debt;
and (iii) the need to prepare for formidable longer-term challenges on public finances—notably, rising health care costs and aging. Accordingly, the assumed fiscal consolidation in
the scenario is broadly in line with stabilizing public debt-to-GDP ratios at pre-crisis levels.
Total fiscal adjustment in the upside (including what is already in the baseline from G-20
policy frameworks) amounts to approximately 9½ and 6 percent of GDP in advanced deficit
and advanced surplus economies, respectively.
10.
The first layer of the upside scenario considers the following additional (stylized)budgetary actions (see Box 2):

3

See IMF “Fiscal Monitor: Navigating the Fiscal challenges Ahead,” Fiscal Affairs Department, May 2010.

For advanced deficit countries (represented by the United States in the model) as well assome advanced surplus countries (represented by Japan in the model) an additional fiscal
deficit reduction of 3 percentage points is phased in over 5 years, reflecting lower
government consumption by 1 percent of GDP, lower general government transfers by
1½ percent of GDP, and higher tax revenues by ½ percentage point of GDP.4

For euro area surplus countries (represented by Germany in the model) fiscal deficits arelowered by 1 percentage point relative to baseline, with components of the fiscal package
scaled accordingly relative to the U.S. package. Given more pressing fiscal problems foreuro area deficit countries (represented by the euro area excluding Germany in themodel), greater reduction of fiscal deficits is assumed, i.e., 2½ percentage points of GDP,
with the package components also scaled accordingly (the corresponding reduction of
fiscal deficit for the euro area overall is about 2 percentage points of GDP).

For emerging surplus countries (represented by emerging Asia in the model), no fiscal
consolidation is assumed, while remaining countries in the rest of the world pursue fiscal
deficit reduction of 1 percentage point of GDP.

11.
To mitigate the dampening effect on demand, the composition of fiscal
adjustment would be important. The design of fiscal consolidation plans should be“growth friendly” to the extent possible in terms of its composition. Minimizing tax
distortion is a key principle for the design. Within this realm, there are many possible options
and an indicative set of policies considered here is as follows. Recognizing that the effect offiscal consolidation will partly depend on the composition of expenditure and tax
instruments, the model examines the impact of: (i) lower taxes on capital and labor;(ii) higher taxes on consumption; and (iii) entitlement reform (through lower transfers) andsome cuts in government consumption. Specifically:A shift from payroll to consumption taxes facilitates fiscal consolidation, while increasing
medium-term potential output.5 While tax increases may be unavoidable, this should bedone in the least distortionary manner possible. For example, a shift from payroll taxes to
consumption tax (or VAT depending on country circumstances) facilitates fiscal
consolidation by increasing employment and potential output. Other avenues that could
be considered (but are outside the model) include eliminating existing tax distortions,
including those relating to the treatment of financial leverage or energy consumption.



The shift in tax composition—as part of the consolidation—increases overall tax
revenues by ½ percent of GDP and is designed as follows (for the U.S. block in themodel): consumption tax revenues increase by 5 percent of GDP (equivalent to anincrease in consumption tax rates of about 8 percentage points), while labor and capital4

The latter is the net effect of significant changes in the composition of taxes, marginal rates, and tax revenues
from various sources (see ¶11).
5

A shift to consumption taxes would reduce overall tax distortions by lowering the tax burden on work.
Distributional effects from consumption taxes (or VAT) can be alleviated by keeping its structure broad-based,
but with certain key exemptions for items such as food and other basic goods.

income tax revenues decrease by 4½ percent of GDP (equivalent to a cut of 6 percentage
points of the underlying effective tax rates).
12.
Finally, credibility is a critical element for successful fiscal adjustment. Credibility
is defined in terms of what the private sector believes about a certain policy action. With
less-than-full credibility of fiscal plans, private expectations anticipate some reversal orslippage in consolidation. If investors and consumers doubt that the package would be fully
implemented, investment and employment responses over the near term would be weaker
than otherwise. However, if economic agents gain confidence in fiscal implementation,
expectations would closely align with the goals of a (fully-credible) consolidation strategy.
Then, the growth-enhancing effects (e.g., through lower interest rates) of the fiscal package
would be realized sooner. Clear and effective communication of coherent consolidation plans
and strengthening of budgetary institutions and frameworks would help fiscal credibility visà-vis the private sector. For the upside scenario:


Fiscal policies are assumed to steadily gain credibility over time. Where applicable,
additional consolidation starting in 2011 is assumed relative to the plans in G-20 policy
frameworks; all measures are phased in gradually over 5 years, with policies gaining fullcredibility by the third year of the consolidation plan (i.e., in 2013). Concretely, private
expectations in the model align with the authorities’ fiscal consolidation objectives fromthis point onwards.

13.
The scenario shows that fiscal consolidation alone—while supportive of growthin the medium term—in advanced G-20 economies would dampen growth in the shortrun, including for G-20 partner countries (Figure 1). For advanced economies, thesimulated fiscal consolidation lowers real GDP relative to the baseline, primarily reflecting
lower disposable income and aggregate demand. Monetary policy mitigates the slowdown byremaining accommodative longer relative to the baseline. As credibility of fiscal policy
increases over time, private spending is increasingly “crowded in.” Investment andemployment increase and economic activity gains momentum, resulting in higher real GDP
relative to the baseline over the medium term. For emerging Asia and ROW, however, real
GDP remains lower relative to the baseline over the projection horizon, given their highexport dependence. Weaker external demand (relative to the baseline) from advanced
partners more than offsets the benefits of lower interest rates globally.
14.
Thus, the case for global rebalancing is strong. More credible fiscal adjustment
would mitigate but would not likely reverse the decline in domestic demand in thoseeconomies undergoing consolidation. Current account deficits would narrow in advanced
deficit countries, matched by lower external surpluses in emerging and advanced surplus
countries. The euro area current account would be broadly unchanged, but imbalances within
the area would narrow. While global imbalances would narrow, global growth would belower. This reflects insufficient rebalancing of global demand.
15.
Stronger fiscal consolidation would allow monetary accommodation to be
maintained for a longer time to help support activity. Owing to large and credible fiscal
consolidation, sovereign risk premia and long-term interest rates decline. Combined with thelower capital income taxes, investment is “crowded in,” and the shift away from labor taxes
increases employment, boosting the supply potential significantly. Accordingly, monetary
policy in advanced economies could afford to stay accommodative for a more extended

period, since inflation pressures remain contained and inflation expectations are wellanchored.
B. STRUCTURAL REFORM TO STRENGTHEN DEMAND IN EMERGING ECONOMIES
16.
To support stronger global growth, steps to strengthen internal demand in
emerging economies are also considered. The next layer in the upside scenario focuses on
the multilateral implications of policy measures in emerging economies (particularly, thosewith large external surpluses) to boost internal demand, given the weaker outlook for external
demand from advanced partner countries undergoing consolidation.
17.
Policy measures in emerging economies aiming to reduce high precautionarysaving and to eliminate existing economic distortions appear desirable. While specificstructural reform measures would need to be tailored to individual country needs andcircumstances, the following (stylized) structural reforms are considered in the model:Key reforms for emerging surplus economies in the upside are strengthening social safety
nets, namely pension and health insurance, together with increased exchange rate
flexibility to facilitate the rebalancing of demand towards domestic sources. Higher
infrastructure spending in fast-growing economies—including in major oil exporters who
are grouped in the model with remaining countries in the rest of the world—is also
considered to alleviate supply bottlenecks. Other policy areas that are also relevant (butoutside the model) include reform of corporate governance and financial market
development that could further lessen household precautionary saving by raising capitalincome and could lower high corporate saving in some emerging economies.

Stylized reform policies should be taken as illustrative. Given differences in economic
circumstances among emerging economies, specific policy priorities differ for eachcountry. For a more detailed description of structural policies for each thematic grouping,based on priorities identified by the OECD and Fund staff, see Box 3.

18.
Policies that enhance social safety nets and improve infrastructure in emerging
economies would boost their growth and support global activity. In the upside scenario, a
gradual increase of government investment of 2 percent of GDP implemented over 3 years in
the emerging Asia region of the model increases domestic demand (notably, investment)
relative to the outcome in the first layer of the scenario. In addition, strengthening of safety
nets through targeted transfers to the poor (who tend to be borrowing constrained)—amounting to around 2 percent of GDP—further increases domestic demand in emerging
Asia. Half of the policy measures are financed through higher deficits given available fiscal
space, and the other half through higher consumption taxes. Higher infrastructure spending
and enhanced safety nets in emerging Asia also improve growth outcomes in ROW, relative
the fiscal consolidation scenario alone (Figure 1).

Figure 1. G-20 Upside Scenario(Deviation from baseline)
Unemployment Rate

Real GDP

4

United States

2
0
-2

0

15

-1

10

-2

5

-3
2010

6

Real Effective Exchange Rate

(Percentage points)(Percentage points; + = Depreciation)
Fiscal consolidation in advanced economies (Layer 1)
Adding infrastructure and safety net spending in emerging economies (Layer 2)
Adding labor and product market reforms (Layer 3)
1
20
United States
United States(Percent)

2011

2012

2013

2014
2

Euro Area 1/

0
2010

2011

2012

2013

2014

0

2014

2012

2013

2014

1

-2

-4
2010

2011

2012

2013

2014
2

of which Germany

0

2

-2

0

-4

-2

0
2010

4

2011

2012

2013

2014

2011

2012

2013

2014

of which Germany

2

2011

of which Germany

2
1
0
2010

0.5

Japan

2010
3

-6
2010

2011

2012

2013

2010

2014
15

Japan

2011

2012

2013

2014

2011

2012

2013

2014

2011

2012

2013

2014

2011

2012

2013

2014

Japan

10

0.0

1

5
-0.5

0
-1

0

-1.0
2010

2011

2012

2013

2014

-5
2010

2011

2012

2013

2014

2010
5

Emerging Asia

1

0

0

-5

-1

-10

-2

Emerging Asia

-15
2010

3

2013

2

-2

0

2

2012

3

2

3

2011

Euro Area 1/

4

4

6

2010
5

Euro Area 1/

2011

2012

2013

2014

2010
2

ROW

2

0

1

-2

0

-4

-1

ROW

-6
2010

2011

2012

2013

2014

Sources: G-20 authorities and IMF staff estimates.
1/ Based on PPP-weighted average of Germany and the other euro area members.

2010

C. Product and Labor Market Reform to Enhance Potential
19.
The final layer involves key structural policies to repair damage to supply
potential after the crisis and reduce high unemployment, particularly in some G-20
advanced economies. Policies needed to address key supply constraints can be summarized
by thematic groups as follows: for advanced surplus economies, labor and product market
policies should enhance growth and job creation and reduce high unemployment; foradvanced deficit economies, the focus should also be on implementation of comprehensive
financial sector reform (outside the model), in combination with entitlement reform andcredible fiscal consolidation. However, policies are likely to differ across countries withineach group. Country-specific policies therefore, should be designed with a view of countries’
needs and economic circumstances. As an illustration, the following stylized reform
measures are introduced in the third layer of upside scenario:
Product market reform that strengthen competition in key sectors. The simulationconsiders the effects of reducing barriers to competition in network industries, promoting
competition in professional services and retail distribution, and simplifying productmarket regulation.

Easing the restrictiveness of product market regulation to appreciably improve
productivity. The effectiveness of such reform is derived from OECD analysis (seeBox 4). Specifically, moving toward “best practices” (defined in terms of OECD
restrictiveness indices) raises overall productivity growth—particularly, in G-20
advanced surplus economies—in the range of ¼ to over ½ percentage point per year in
the upside, after taking into account what is already achieved by G-20 baseline policies(see Box 5).

For emerging deficit economies, policy efforts are focused on simplifying product market
regulation.

20.
Coherent structural reform is also needed to strengthen demand along with
supply. A singular focus on boosting supply potential is too narrow. Reform should also be
mindful of not dampening demand. Thus, policies that aim to improve the functioning oflabor and product markets, for example, should complement (not contradict) measures that
aim to reduce high precautionary saving in some G-20 economies (i.e., reform plans toenhance supply potential should be coherent with other reforms outlined in Section B). This
would involve striking the right balance between policies that promote greater market
competition or flexibility with those preserving social safety nets that provide income
insurance or equity. For instance, as stressed by the ILO, reforms that further encouraged
growth of real wages in line with enhanced productivity gains would be essential to ensurethat the benefits of structural reform are widely shared. Key design principles that would help
achieve these multiple objectives (e.g., both positive supply- and demand-side effects)
include complementary reforms that can be mutually reinforcing; and credible reform that
improves income and job prospects. These are elaborated below.
21.
To complement product market reform, key labor market policies would further
enhance growth prospects and reduce high unemployment. Labor market reforms that
could increase employment include measures that lower hiring costs, reduce long-term
unemployment (by facilitating re-entry), and encourage job search, matching, and mobility.
Complementary product market reforms could strengthen the employment effects byboosting labor demand and real wages (through greater competition and lower mark-ups on
prices). Finally, fiscal actions that lower payroll taxes or other non-wage costs (e.g., social
security contributions) could also strengthen the employment effect in the upside. 6Effective labor market reforms—paired with complementary policy actions—would
improve growth and employment outcomes in advanced economies, particularly inEurope. In the model simulations, employment in some advanced surplus and advanced
deficit countries (Germany and the euro area overall)7 increases by 3 percent.8 Improved
labor markets in Europe would have positive spillovers in the upside scenario. In otheradvanced deficit economies and in the rest of the G-20 (the United States, emerging Asia,
and rest of the world), it rises by 1 percent, and in Japan by about ½ percent.

Credibility of the effectiveness of structural reforms is also crucial. In the model,
employment and productivity gains from the reforms are gradually built into private
agent expectations (i.e., as with fiscal policy, structural reforms steadily gain credibility
over time). To the extent that such credibility is missing, some structural reforms could
temporarily dampen growth. With higher expected productivity, firms increase
investment and payrolls; with higher expected income and better job prospects,
consumption also gradually strengthens in the upside. In emerging Asia and ROW,
growth improves appreciably due to their own additional product market reforms relative
to the first and second layers of the upside, “fiscal consolidation” and “enhanced safetynets”, respectively (Figure 1).

22.
Beyond stronger growth, collective policy action across G-20 members results inmore balanced global demand (Figure 2). Specifically, in advanced deficit economies, on
the back of higher saving and stronger external demand, current account deficits decline
relative to the baseline. In advanced surplus economies, current account surpluses fall, as
product and labor market reforms boost investment demand and private consumption.
Finally, in emerging surplus countries, current account surpluses decline, as improved safety
nets lower precautionary private saving and together with higher infrastructure spending
increase domestic demand. While these effects are significant, the major drivers of current
account adjustments are changes in public and private saving rates, most importantly the
relative sizes of fiscal consolidations across regions.

6

ILO inputs stress the need for reform proposals—in consultation with social partners—that reduce non-wage
costs to support labor demand; maintain unemployment benefits for job seekers; support “up-skilling” andworker mobility; tackle long-term unemployment through measures that facilitate re-entry; and address highyouth unemployment through education, vocational training and internships.
7

Technically, euro area countries excluding Germany in the model comprise both advanced deficit and surplus
countries, but structural reform to raise low potential output growth is needed in both groups. In the model,
Germany’s relatively larger benefits from product market reform partly reflect larger spillovers from higher
productivity in others due to its greater openness.
8

A package of labor market policies broadly consistent with achieving the simulated increase in employment
would include implementing OECD Going for Growth priorities such as reduction in labor tax wedges andincreased spending on cost-effective active labor market policies (ALMP), starting in 2012 and phased in
gradually.

Figure 2. G-20 Upside Scenario(Deviation from baseline)
Fiscal Balance

Current Account(Percentage points of GDP)

(Percentage points of GDP)

1.0

United States

Fiscal consolidation in advanced economies (Layer 1)
Adding infrastructure and safety net spending in emerging economies (Layer 2)
Adding labor and product market reforms (Layer 3)3
United States
2

0.5
1
0

0.0
2010
0.6

2011

2012

2013

2010

2014
2.5

Euro Area 1/

2011

2012

2013

2014

2011

2012

2013

2014

2011

2012

2013

2014

2011

2012

2013

2014

2011

2012

2013

2014

2011

2012

2013

2014

Euro Area 1/

2.0

0.4

1.5
0.2
1.0
0.0

0.5

-0.2

0.0
2010

0.5

2011

2012

2013

2010

2014
1.5

of which Germany

0.0

of which Germany

1.0

-0.5
0.5

-1.0
-1.5

0.0
2010

1.5

2011

2012

2013

2010

2014
3

Japan

1.0

2

0.5

1

0.0

0
2010

2

2011

2012

2013

2014

2010
1

Emerging Asia

0

0

-2

-1

-4

Emerging Asia

-2
2010

0.2

Japan

2011

2012

2013

2014

2010
0.8

ROW

0.0

0.6

-0.2

0.4

-0.4

0.2

-0.6

ROW

0.0
2010

2011

2012

2013

2014

2010

Sources: G-20 authorities and IMF staff estimates.
1/ Based on market-based exchange rate weighted average of Germany and the other euro area members.

23.

Compared to the refined baseline, key gains in the upside are as follows:Global GDP is around 2½ percent higher over the medium term. World output would behigher by over 1½ trillion U.S. dollars, lifting an estimated 33 million people out ofpoverty.9 The growth gains (and policy adjustments) relative to the baseline are largest
for most advanced economies who suffered the largest damage from the crisis. Output
gains in Japan and ROW, while somewhat smaller, are also sizable. In emerging Asia,
where GDP effects are smaller, output is nonetheless higher relative to the baseline due tocomplementary domestic policy action. More importantly, GDP in emerging Asia issignificantly higher than in the case with no further policy action across regions (i.e.,
relative to the “fiscal consolidation in advanced economies” scenario).



Unemployment is reduced, ranging from ¾ to 3¾ percentage points across regions. The
reduction is significant in several cases, particularly in advanced surplus economies
where unemployment has
Upside Scenario: Employment and Output Gains
been persistently higher(Relative to the refined baseline in 2014)
Employment
Unemployment 1/
Real GDPfollowing the crisis.
(Millions)(Percentage points)(2009 USD billion)(Percent)
Accordingly, an estimatedUnited States
3.1
-2.0
426
3.0
Euro area 2/
4.6
-2.8
563
4.5
8 million more jobs wouldof which Germany
1.6
-3.8
174
5.2
be created in advanced
Japan
0.5
-0.8
126
2.5
Emerging Asia
13.2
-0.7
128
1.4
economies, and roughlyof the world
8.2
-1.1
370
2.1
21 million in emerging Asia Rest
World
29.5
-1.4
1614
2.5
and rest of the world,
Sources: G-20 authorities and IMF staff estimates.
For emerging Asia and rest of the world, as unemployment is not modeled in GIMF, its response to shocks is
expanding total employment 1/calculatedusing the output response for these blocks and assuming the maximum estimated response of unemployment
to output of the other blocks.
by close to 30 million jobs
2/ Based on PPP-weighted average of Germany and the other euro area members; employment and real GDP level is asum of Germany and the other euro area members.
around the globe. The
numbers are credibly supported by ambitious labor market reform, complemented byproduct market reform, and more efficient taxation policies in advanced economies.

24.
The simulations show clear benefits of collective action across all regions. The
main result is that multilateral policy actions appreciably strengthen G-20 outcomes, and on asounder policy basis, in terms of stronger, more balanced and sustainable growth. Global
demand is rebalanced across regions, while robust global growth is maintained. This result islargely achieved due to the stronger growth in surplus countries, driven by higher domestic
demand and supported by exchange rate flexibility. This boosts exports in advanced deficit
countries, compensating for greater fiscal retrenchment. Another important outcome is lower
unemployment over the medium term.
25.
Exchange rate adjustment is an integral part of the rebalancing and helps toachieve G-20 growth objectives. Overall, global GDP growth is higher (by ½ percentage
point) and more sustainable, as global imbalances (sum of absolute current account balances)
narrow by ¾ percent of global GDP—i.e., a reduction of 25 percent. In the upside scenario,
which as mentioned previously is purely illustrative, real effective exchange rate movements
associated with collective action are significant in some cases (see Figure 1). This suggeststhat impediments to nominal exchange rate flexibility would hamper global rebalancing.
9

See companion report “G-20 and Global Development,” prepared by the World Bank.

With flexible exchange rates, an estimated 10 percent appreciation of real effective exchange
rates in emerging Asia and about 5 percent in the rest of the world is accompanied bystronger domestic demand and higher growth (up 0.3 and 0.4 percentage points,
respectively), while current account surpluses are reduced by 3 and 0.4 percentage points ofGDP, respectively. Similarly, real effective depreciation between 5 and 15 percent inadvanced deficit economies is associated with about 1 percentage point of GDP lower current
account deficits, while growth is about ½ percentage points higher.
IV. DOWNSIDE SCENARIO—COSTS AND REACTIVE POLICIES26.
The downside scenario explores the implications of key risks for the G-20, if they
were to materialize. The initial analysis identified several key risks. Notably, potential
output may be appreciably lower after the financial crisis and could be hurt by further delays
in repair of the financial system. Also, given recent events in sovereign debt markets, market
concerns about public debt sustainability pose risks of higher interest rates and tighter
financial conditions. This scenario analyzes both the consequences for G-20 outcomes andthe attendant policy actions that would be required under more stressful circumstances. The
analysis explores the mitigation of risks to help avoid downside losses (or policies to achieve
better outcomes if risks were to materialize) and how they depend crucially on the strength,
commitment, and quality of the policy action. Reactive policies forced into damage control,on the other hand, could be less effective than those implemented under more favorable
circumstances.
27.
Risks surrounding fiscal sustainability and heightened market concerns have
moved front and center. Against the backdrop of recent market developments, higher
sovereign interest rate risk premia are a key risk belonging to the downside scenario.
Insufficiently credible adjustment plans may result in sharp increases of these risk premia—
dampening growth in the affected economies, with an impact on public debt (both directly
and indirectly). Moreover, the credibility of (forced) fiscal adjustment would likely be lower
in a downside scenario, likely affecting the impact on private spending.
Furthermore, fiscal risks in advanced economies could create adverse spillovers forfinancial markets and for emerging economies. Higher sovereign spreads would have
implications for the banking sector, through mark-to-market losses and higher funding
costs. Higher sovereign risks (and benchmark interest rates) could also raise borrowing
costs for firms. Emerging economies are vulnerable to swings in interest rates (currently
at low levels) and may be affected by related swings in capital flows, as they may cause
boom-bust cycles, increased volatility, and lower domestic growth over the medium term.

28.
Another key risk is that supply potential is considerably lower in the aftermathof the crisis. In particular, for advanced economies at the epicenter of the crisis, potential
may be lower than assumed in the G-20 MAP frameworks. Key issues are as follows:

Uncertainty about regulatory reform and the lending capacity of the financial systemposes non-negligible risks to growth. Further delays in repair of the financial system
would lead to a less efficient allocation of credit, weaker overall credit provision, hurting
economic activity, and, thus, greater risks of adverse macro-financial feedback loops.
This should be weighed against certain financial sector reforms such as tightening
regulatory standards and prudential norms (e.g., minimum capital requirements)—beyond
what is internalized in the G-20 “base case”—that could themselves limit credit supply.



Weaker potential output would have adverse implication for fiscal positions. In advanced
economies, lower growth than projected in the MAP would result in lower tax revenues,
higher-than-projected fiscal deficits, and rising public debt burdens (already at highlevels). This could reinforce market concerns about debt sustainability. These twoelements constitute key elements of the downside scenario.

29.
If downside risks were to materialize, large output and unemployment losses
would be sustained (Figure 3). A plausible simulation suggests that cumulative output andjob losses of about 2 to
Downside Scenario: Employment and Output Losses(Relative to the refined baseline in 2014)
6 percent and around ½ to over
Employment
Unemployment 1/
Real GDP
1½ percentage points (in terms(Millions)(Percentage points)(2009 USD billion)(Percent)
United States
1.6
1.0
765
5.4
of the unemployment rate),
Euro area 2/
2.1
1.3
705
5.6
respectively, relative to theof which Germany
0.7
1.6
192
5.7
1.0
1.5
244
4.8
refined baseline in 2014. To put Japan
Emerging Asia
11.3
0.6
109
1.2
this in some perspective and toRest of the world
6.6
0.9
301
1.7
22.7
0.9
2124
3.1
better appreciate the benefits of World
collective action, note that
Sources: G-20 authorities and IMF staff estimates.
1/ For emerging Asia and rest of the world, as unemployment is not modeled in GIMF, its response to shocks is
calculated using the output response for these blocks and assuming the maximum estimated response of unemployment toglobal GDP would be aoutput of the other blocks.
2/ Based on PPP-weighted average of Germany and the other euro area members; employment and real GDP level is adramatic 5¾ percentage points
sum of Germany and the other euro area members.
lower in the downside scenario
relative the upside scenario.
30.
In the downside scenario, policies would be forced into a reactive stance and may
not be as effective (Figure 4). Key reasons are market expectations and political economy
constraints.


Fiscal consolidation in the event of deteriorating market sentiment and lower potential
output would need to be stronger and more front-loaded to try to reassure markets. On
the back of lower potential, public finances would worsen given lower tax revenues andautomatic stabilizers, pushing up interest rates with likely adverse feedback effects on
growth and confidence.

In such an environment, effectiveness of fiscal adjustment would likely be significantly
reduced. Compared to the upside scenario, much larger fiscal consolidation would beneeded to ensure the sustainability of public finances. Moreover, credibility would belacking if fiscal adjustment were forced by adverse market reaction, reinforcing (rather
than mitigating) negative demand effects.10

Moreover, many structural reforms may not be politically feasible in the downside.
Stronger policy responses would be needed in the downside generally. However, key
entitlement reform (to raise retirement ages in line with life expectancy), relaxing
employment restrictions (to lower hiring costs), or lowering unemployment benefits or
duration (to encourage job search) would likely be out of reach politically.

10

To model this, the downside scenario assumes little or no credibility for reactive fiscal consolidation.
Specifically, private sector expectations anticipate rising (not falling) budget deficits.

Figure 3. G-20 Downside Scenario(Deviation from baseline)
Unemployment Rate

Real GDP(Percentage points)(Percent)
Lower potential output growth and tightening in credit conditions (Layer 1)2

2

United States

Real Effective Exchange Rate
(Percentage points; + = Depreciation)

Adding increase in fiscal pessimism and risk premia (Layer 2)
5United States

0

United States

-2
0

1

-4
-6
-8
2010
2

2011

2012

2013

2014

2010
2

Euro Area 1/

-5

0

0

2011

2012

2013

4

Euro Area 1/

3

1

-2

2012

2013

2014

2012

2013

2014

Euro Area 1/

2

0

0

-6

-1

-8

-1
2010

2011

2012

2013

2014
2

of which Germany

-2
2010

0

2011

2012

2013

2014

2010
3

of which Germany

2011

of which Germany

2

1

-2

1

-4

0

0

-6
-8

-1
2010

2

2011

1

-4

2

2010

2014

2011

2012

2013

2014
2

Japan

-1
2010

2011

2012

2013

2014

2010
5

Japan

2011

2012

2013

2014

2011

2012

2013

2014

2011

2012

2013

2014

2011

2012

2013

2014

Japan

0
1
-2

0
0

-4
-6

-1
2010

2011

2012

2013

2014

-5
2010

2011

2012

2

2013

2014

2010
4

Emerging Asia
0

2

-2

0

-4

-2
2010

2

Emerging Asia

2011

2012

2013

2014

2010
2

ROW

0

0

-2

-2

-4

ROW

-4
2010

2011

2012

2013

2014

Sources: G-20 authorities and IMF staff estimates.
1/ Based on PPP-weighted average of Germany and the other euro area members.

2010

Figure 4. G-20 Downside Scenario(Deviation from baseline)

Fiscal Balance

Current Account

1.0(Percentage points of GDP)
(Percentage points of GDP )Lower potential output growth and tightening in credit conditions (Layer 1)
Adding increase in fiscal pessimism and risk premia (Layer 2)
1
United States
United States

0.5

0

0.0

-1

-0.5

-2
2010

2011

2012

2013

2014

2

2010
1

Euro Area 1/
1

0

0

-1

-1

2012

2013

2014

2011

2012

2013

2014

2011

2012

2013

2014

2011

2012

2013

2014

2011

2012

2013

2014

2011

2012

2013

2014

Euro Area 1/

-2
2010

2011

2012

2013

2014

2

2010
1

of which Germanyof which Germany
1

0

0

-1

-1

-2
2010

0.5

2011

2011

2012

2013

2014

2010
1

Japan

Japan

0
0.0
-1
-0.5

-2
2010

1

2011

2012

2013

2014

2010
0.5

Emerging Asia

0

0.0

-1

-0.5

-2

-1.0
2010

1

Emerging Asia

2011

2012

2013

2014

2010
0.5

ROW

0

0.0

-1

-0.5

-2

ROW

-1.0
2010

2011

2012

2013

2014

2010

Sources: G-20 authorities and IMF staff estimates.
1/ Based on market-based exchange rate weighted average of Germany and the other euro area members.

V. BENEFITS AND PRIORITIES OF COLLECTIVE POLICY ACTION
31.
Collective action by the G-20 would entail substantial benefit to the membershipby strengthening growth and reducing risk. Policies that advance progress toward thegrowth objectives of the G-20 are also the best option toward mitigating downside risk. In
other words, strengthened policy actions associated with the upside scenario also would help
avoid the adverse dynamics attached to the downside scenario. Comparing the differences inoutcomes between these two scenarios point to much larger potential benefits. Accordingly,
policies associated with the upside should be pursued whether or not signs of the downside
emerge.
Comparing the outcome of the two scenarios (Figures 5 and 6), the sum of upside gains
and the avoidance of downside losses would yield nearly 4 trillion dollars or 5¾ percent
higher global GDP. The number of jobs that would be created (or saved) globally would
total an estimated 52 million. These gains would favorably change the balance of people
living in poverty by more than 90 million persons across the two scenarios.

32.
G-20 policies should be prioritized to maximize the global benefit. The list ofpolicy options to credibly strengthen outcomes and mitigate risks is broad ranging across theentire membership, but key priorities stand out that the G-20 should consider towardachieving their shared objectives.
With continuing sovereign debt market stress, fiscal consolidation in advanced
economies, based on high-quality measures of sufficient magnitude to restore debt ratios
to prudent levels, should be a priority. In the downside, reactive policy action would beless effective and unable to access the full benefits associated with the upside. Thus,
avoiding the downside scenario would be crucial.

Also, advanced economies need to accelerate financial sector repair and reform. Longawaited progress in this area is instrumental for reducing regulatory uncertainty andbuilding a stronger financial system, supporting credit provision, and fostering a more
rapid return to robust and sustainable growth.

Complementary structural reforms in advanced surplus economies would raise their
supply potential, while taking pressure off public finances. Action to reform labor andproduct markets, paired with fiscal action that also reduced non-wage costs, would
strengthen growth and employment. Such reforms would boost demand along with
supply.



Finally, structural reforms in emerging surplus economies would help rebalance global
demand. Combined with more flexible exchange rates, reforms that enhanced social
safety nets, developed financial markets, reformed corporate governance and minimized
key economic distortions would allow for stronger internal demand and more sustainablegrowth in these countries, given external conditions.

Figure 5. G-20 Upside versus Downside Scenario
Real GDP(Deviation from baseline)
Unemployment Rate

(Percent)(Percentage points)

Real Effective Exchange Rate
(Percentage points; + = Depreciation)

Upside422United States

Downside20

United States

1

15

0

10

-4

-1

5

-6

-2

0

-3

-5

0
-2

-8
2010
6
4
2
0
-2
-4
-6
-8

2013

2014

2010
2
1

2011

2012

2013

5
4
3
2
1
0
-1
-2

Euro Area 1/

0
-2
-3
-4
2011

2012

2013

2014

of which Germany

2011

2010
3
2
1
0
-1
-2
-3
-4
-5

2012

2013

2014

2

2012

2013

3

2013

2014

2011

2012

2013

2014

of which Germany

1
0
-1
2011

2012

2013

2014

2010
10

Japan

2011

2012

2013

2014

2011

2012

2013

2014

2011

2012

2013

2014

2011

2012

2013

2014

Japan

5
0

-2

0

-5

-4
-6

-1
2010

2

2012

2

1

0

2011

Euro Area 1/

2010

2014

of which Germany

2010
2

Japan

2011

2010

2014

-1

2010
4

2012

Euro Area 1/

2010
6
4
2
0
-2
-4
-6
-8

2011

United States

2011

2012

2013

2014

-10
2010

2011

2012

2013

2014

2010
5

Emerging Asia

1

Emerging Asia

0

0
-5

-1

-10

-2
-3

-15
2010

3
2
1
0
-1
-2
-3
-4

2011

2012

2013

2014

2010
5

ROW

ROW

0
-5
-10
2010

2011

2012

2013

2014

Sources: G-20 authorities and IMF staff estimates.
1/ Based on PPP-weighted average of Germany and the other euro area members.

2010

Figure 6. G-20 Upside versus Downside Scenario(Deviation from baseline)
Fiscal Balance

Current Account(Percentage points of GDP)

(Percentage points of GDP )Upside1.0

Downside3

United States

United States

2
0.5

1
0

0.0

-1
-0.5

-2
2010

2011

2012

2013

2014

2010
3

1.4
Euro Area 1/

2011

2012

2013

2014

2011

2012

2013

2014

2011

2012

2013

2014

2011

2012

2013

2014

2011

2012

2013

2014

2011

2012

2013

2014

Euro Area 1/

2

1.0

1
0.6
0
0.2

-1

-0.2

-2
2010

2011

2012

2013

2

1.5
1.0

of which Germanyof which Germany
1

0.5

0

0.0
-0.5

-1

-1.0
-1.5

-2
2010

1.5

2010

2014

2011

2012

2013

2010

2014
3

Japan

Japan

2

1.0

1
0.5
0
0.0

-1

-0.5

-2
2010

1.0

2011

2012

2013

2010

2014
1

Emerging Asia

Emerging Asia

0.0
0

-1.0
-2.0

-1

-3.0
-4.0

-2
2010

0.2
0.0
-0.2
-0.4
-0.6
-0.8
-1.0
-1.2

2011

2012

2013

2014

2010
1.0

ROW

ROW

0.5
0.0
-0.5
-1.0
2010

2011

2012

2013

2014

2010

Sources: G-20 authorities and IMF staff estimates.
1/ Based on market-based exchange rate weighted average of Germany and the other euro area members.

Box 1. G-20 “Base Case” and Technical Adjustments for the Refined Baseline
The “base case” scenario was derived from the completed “raw” submissions by G-20
members. First, after receiving the “raw” inputs from the G-20, Fund staff assessed the internalconsistency of the submissions. Second, to address consistency across the G-20 members, staff usedthe completed “raw” submissions to construct common global assumptions consistent with G-20
inputs. This included external assumptions for oil prices (taken as the average from G-20 “raw”
inputs), partner country growth (consistent with G-20 “raw” inputs for domestic growth), partnercountry inflation, and so on. Finally, harmonizing on this set of global assumptions and making(mechanical) adjustments where needed to the “raw” submissions, a G-20 “base case” scenario wasconstructed.
The “base case” was further refined to resolve two technical issues. The refinements were done
first, to impose greater multilateral consistency of output gaps and to better anchor simulations for thealternative scenarios simulations; and, second, to reflect recent market and economic developments.
The analytical framework used to ensure greater multilateral consistency in the refined MAP
baseline draws from the IMF’s Global Projection Model (GPM).11 GPM is a theory-based
macroeconomic model with trade and financial linkages, featuring nominal and real rigidities in the
short run and real business cycle properties in the long run. A particularly useful feature of model inthe context of the G-20 MAP is that it produces multilaterally and model-consistent measures of key
unobservable variables such as the output gap or the unemployment gap.
Notwithstanding growing downside risks from financial markets, the G-20 MAP “base case”
was adjusted upwards over the near term, reflecting better-than-expected developments in thereal economy over the past several months. In particular, in the United States 2010Q1 real GDP
growth turned out stronger and labor markets and financial conditions improved more than earlier
envisaged. At the same time, in the euro area industrial production expanded rapidly; in Japan GDP
growth in 2010Q1 was strong, driven by exports and rebounding investment, while consumption
growth was moderate; and emerging Asia continues on a path of strong and sustained recovery.
However, the “base case” was adjusted downwards over the medium term, reflecting moreconservative estimates of potential output for the advanced countries at the epicenter of thefinancial crisis. These estimates are in line with recent empirical findings that show large potential
Refined MAP Projections of Real GDP Growth 1/
output losses in the aftermath of
122010 - 2014
severe financial crises.
2010
2011
2012
2013
2014
Average
Accordingly, real GDP growthDifference from "base case" (percentage points)
0.5
-0.1
-0.2
-0.7
-0.8
-0.2
in advanced deficit countries at World
United States (20.7)
0.5
-0.3
-1.1
-1.9
-1.5
-0.8
the epicenter of the financial
Euro Area (15.4)
-0.0
0.0
0.1
-0.3
-0.8
-0.2
Japan (6.2)
1.0
-0.1
0.3
-0.0
-0.5
0.1
crisis was marked down,
Emerging Asia (23.7) 2/
0.3
-0.2
0.1
-0.3
-0.2
-0.1
Rest of World (34.0)
0.7
0.0
-0.1
-0.5
-0.8
-0.1
bringing it more in line with
Refined baseline (percent)Memorandum
growth of advanced economies World
4.5
4.7
4.8
4.4
4.3
4.5
further away from the crisis. As Sources: G-20 authorities and IMF staff estimates.
1/ Share of world GDP by PPP in parenthesis (2007 - 2010 average, percent).
a result, accounting for trade
2/ Includes: China, Hong Kong SAR, India, Indonesia, South Korea, Malaysia, Philippines, Singapore, Taiwan
Province of China, Thailand.
linkages, real GDP growth in
the euro area, and Japan, emerging Asia, and rest of the world was also scaled down.
11

For a description of the model see Clinton, K., Garcia-Saltos, R., Johnson M., Kamenik O., and Laxton D.,“International deflation risks under alternative macroeconomic policies,” Journal of the Japanese andInternational Economies, 2010, and references therein.
12
World Economic Outlook, Chapter 4, International Monetary Fund, October 2009.

Box 2. Growth-Supportive Fiscal Consolidation
This box discusses a stylized package of fiscal policies designed to achieve fiscal consolidation,
while supporting growth over the medium term. The upside scenario explores the role of threecore elements of the fiscal consolidation package. In particular: (i) sufficient scale; (ii) growthfriendly composition; and, (iii) strengthened credibility of fiscal plans, along the following lines.
The scale and composition of the package should take into account country-specificcircumstances. The timing and magnitude of consolidation should be tied to country circumstances.
For the purpose of the upside scenario, based on Fund staff assessment of fiscal consolidation needs
in each country or region, the (stylized) fiscal package is constructed as follows:

For the United States. The fiscal deficit is reduced by 3 percentage points of GDP. To lessen
the contractionary effect of the deficit reduction, part of it is financed through a growthsupporting shift in the composition of taxation from income to consumption. Specifically, a
reduction in labor and capital income taxes by 4.5 percent of GDP (approximately 6 percentage
points cuts in the effective tax rates, each) is more than offset by a 5 percent of GDP increase in
consumption tax revenue (i.e., an increase of consumption tax rate by 8 percentage points). The
rest of the deficit reduction is financed by cutting government consumption and general
government transfers by 1 percent of GDP and 1½ percent of GDP, respectively.

For the rest of the countries or regions. The above fiscal package is scaled as follows: In Japanthe size of the package is as in the U.S.; in the euro area excluding Germany, it is slightly over
80 percent of the size in the U.S.; in Germany and rest of the world it is 1/3 of the size in the
U.S., while in emerging Asia, no adjustment is assumed.

Credibility is a critical element for successful fiscal adjustment. Credibility is defined in terms ofwhat the private sector believes about the fiscal policy action. Under partial credibility, markets
anticipate some reversal or slippage in consolidation and thus, investment and employment
responses over the near term would be weaker than otherwise. However, if economic agents havefull credibility in fiscal plans, then, the growth-enhancing effects (e.g., through lower interest rates)of the fiscal package would be realized sooner. In the upside scenario, fiscal policies are assumed tosteadily gain credibility over time. Where applicable, starting in 2011 additional consolidation isassumed relative to the plans in G-20 policy frameworks; all measures are phased in gradually over
5 years, with policies gaining full credibility by the third year of the consolidation plan (i.e., from2013 onwards private expectations in the model are aligned with the authorities’ fiscal consolidation
objectives in each country).
The motivation behind the above fiscal package is to support growth over the medium term. In
the near term growth declines slightly relative to the refined baseline due to negative multipliereffects of lower government spending and an initial lack of credibility. However, the policy
measures boost growth significantly over the medium term for two reasons. First, lower deficits
increase saving and thus, reduce real interest rates over time. Second, with the supply of labor andcapital relatively elastic over the longer term, while consumption demand is relatively inelastic, ashift of the tax burden towards consumption reduces distortions, and, therefore boosts output.

Box 3. Stylized Structural Reform Package by Thematic Grouping
The choice of stylized package of structural reforms for each thematic grouping is crosschecked with the OECD findings. OECD Going for Growth reports identify actions that could
boost long-term growth. While structural reform priorities vary by country, some generalizationis possible for the thematic groupings identified in the initial assessment report. However, thedegree of specificity varies within the thematic groupings and not all priorities are equallyapplicable to all countries in a thematic group. All countries however, should resist protectionist
pressures and aim for a successful completion of the Doha round of the WTO trade negotiations.
Combining the OECD findings with Fund staff recommendations results in the following
structural reform priorities across groupings:
For advanced deficit economies priorities include: for labor markets, reforming disability
benefit schemes; maintaining a flexible wage bargaining system; improving fiscal incentives
for work force participation; reducing wage indexation, and reforming the employment
insurance system. For product markets, strengthening competition in network industries,
reducing restrictions on retail trade, professional services, and rental market, and retail
distribution sector, and improving and streamlining financial regulation. Other reforms
include, restraining health care costs and improving educational outcomes and public
infrastructure.

For advanced surplus economies priorities include: For labor markets, reforming the employment insurance system; reducing the minimum
cost of labor; lowering hiring costs; reducing implicit taxes on continued work at older
ages; reducing average tax wedges on labor income; reducing fiscal impediments to fulltime female labor force participation; decentralizing wage bargaining; raising labormobility within the EU; reforming disability benefit schemes; removing financial
disincentives to work, and, limiting the extent of administrative extension of collective
agreements.
 For product markets, reducing barriers to competition in network industries; further
reducing barriers to foreign ownership and to competition in professional services;
reducing public ownership; and, strengthening competition in the retail distributionsector.
 Other reforms include, improving education outcomes, strengthening innovation system,
and removing restrictions on foreign investment.

For emerging deficit economies priorities include: for labor markets, increasing efficiency of
the formal sector, and for product markets, plans to reform and simplify product market
regulation. Other reform areas include, improving educational efficiency, improving
infrastructure, fostering private sector participation in infrastructure projects, pension reform,
reallocation of some current spending to public investment, and policy enforcement.

For emerging surplus economies priorities include: for labor markets, reduction of
restrictions on labor mobility and moderation of the minimum wage, and for product markets,
reforming product market regulation, reducing FDI restrictions, and further financial andbanking reforms. Other reform priorities, including for major oil exporters are: improving
investment climate, pension reform, improving efficiency of budgetary spending,strengthening the legal system, reducing state control over economic activity, and improving
secondary and tertiary education.

Box 4. Productivity Gains from Product Market Regulation ReformEasing product market regulation (PMR) can enhance total factor productivity (TFP).
This can occur not only in sectors where such regulation is applied, but also in morecompetitive industries that rely on intermediate inputs from those sectors. For example, easing
regulation in upstream (non-manufacturing) sectors could increase TFP growth in both
upstream and downstream (manufacturing) sectors and could have an appreciable economywide impact, although estimates vary.
OECD analysis finds positive effects of reducing PMR restrictions on TFP growth inmanufacturing and non-manufacturing sectors.1 The simulated impact of moving various
OECD countries toward “best practice” in the area of PMR from their 2007 levels is shown in
the table. Specifically, the table shows the average increase in TFP growth in 2011-15 forvarious sectors, if reform is implemented over 10 years starting in 2010. Best practice isdefined as the average of the three levels of regulation least restrictive of competition in eachof several specific areas including energy, transport, communication, retail distribution,
professional services, and banking. The estimates take into account country-specific degree of
regulation, industrial structure, and distance from the technological frontier.
Gains in TFP growth for the period 2011-2015 from reforms implemented over a ten year period starting in 2010
(Annual average, in percentage points)

Euro area ***Euro area excluding Germany ***Germany
Australia
CanadaJapan
Korea
MexicoUnited Kingdom
United States

Manufacturing sectors(15-37)
0.7
0.6
0.7
0.4
0.7
1.3
0.7
0.6
0.5
0.5

Non-manufacturingsectors (40-74)
0.3
0.3
0.3
0.3
0.4
0.6
0.3
0.2
0.2
0.2

Business sectors*(15-74)
0.4
0.4
0.4
0.3
0.5
0.8
0.4
0.3
0.3
0.3

Whole economy**(01-99)
0.3
0.3
0.3
0.2
0.3
0.6
0.3
0.2
0.2
0.2

Source: OECD estimates.
* Excluding the farm sector and the mining and quarrying industries; this field corresponds to the sum of the two previous columns.
** The calculations for the whole economy assume that reforms to upstream sectors have no effect on the farm sector, the mining and quarrying
industries and the non-business sectors.
*** Aggregation done using 2010 PPP weights; excludes Cyprus, Ireland, Luxembourg, Malta, Slovak Republic and Slovenia due to data
unavailability.

The OECD has identified concrete policy actions associated with these productivity
gains. Examples of product market reform, as suggested by OECD’s Going for Growth report,
include reducing barriers to competition in network industries, promoting competition in retail
distribution services, and simplifying product market regulation (see Box 3).
_____
1

R. Bourlès, G. Cette, J. Lopez, J. Mairesse and G. Nicoletti (2010) "Do Product Market Regulations in Upstream Sector Curb
Productivity Growth? Panel Data Evidence for OECD Countries", OECD Economics Department Working Papers(forthcoming) and Banque de France Documents de Travail No. 283 (June 2010).

Box 5. Scaling the Impact of Stylized PMR Reform on Productivity
In collaboration with OECD staff and based on their analysis, Fund staff incorporated
the estimates of product market reforms into the scenario analysis. In the upside scenario,
G-20 economies were assumed to implement more far-reaching PMR reforms thanincorporated in the baseline, over the course of 10 years starting in 2010 (see Box 4). Expected
productivity gains for advanced G-20 economies were drawn from the OECD estimates, after
accounting for gains implicit in the MAP baseline—depending on how well baseline productmarket reform policies align with priority areas. Specifically:In the cases where country plans were judged by Fund staff to be “well aligned” with
OECD structural reform priorities listed in their Going for Growth publications, the OECD
growth paths were scaled by a factor of ½, assuming the other half is already in thebaseline. Where the authorities’ intentions were “broadly aligned,” the scaling factor of¾ was applied. For best-practice economies (two OECD economies for which Going for
Growth does not list any PMR reform priorities) to provide a more realistic upside scenario,
the OECD paths were scaled by a factor of ¼.

For most emerging economies, sufficient information was not available to perform a similar
disaggregated exercise. Instead, expected productivity gains were based on a simple
relation between improving the overall product market environment, as measured by theOECD economy-wide PMR index (which is available for all G-20 economies except
Argentina and Saudi Arabia) and the productivity gains found in the OECD analysis.

The estimates of PMR reform impact on productivity are subject to several caveats:OECD simulations are based on the 2007 indices of PMR in network industries, retail tradeand professional services. To the extent that some reform has occurred between then andnow, the upside potential of further reform may be overestimated. On the other hand, the“best practice” frontier may have moved as well, with an offsetting effect. Realistically,
PMR reforms tend to be rather slow, so not much is likely to have occurred over the last
two years—particularly given those were crisis years.

The scaling to adjust for current reform plans is obviously judgmental, and structuralreform plans in the MAP submissions are not detailed enough to make a more technicalcalculation.



The correspondence between broad PMR indices and specific restrictions used in OECD
simulations is far from perfect. Hence, both the mapping from broad PMR indices into
potential reform gains (for non-OECD countries) and the mapping of reform plans(presented in broad strokes) into scaling factors should be seen as approximate.