Group of Twenty

G-20 Leaders Summit
September 24, 2009
Pittsburgh, U.S.A

Global Economy Beyond the Crisis—
Framework for Sustainable Growth

Prepared by Staff of the International Monetary FundKey Messages
In the aftermath of the financial crisis, a fundamental challenge for policymakers will be tosustain solid global growth. Lessons from past crises suggest that growth prospects may
have been damaged by the impact on balance sheets and, possibly, productive potential.
In this setting, a framework for sustainable growth should contain the following essential
elements—full repair of the financial system to restore efficient intermediation; andrebalancing the global sources of demand (including fiscal consolidation and entitlementreform) to sustain growth.
Reforms to restore a healthy and dynamic financial system, while safeguarding financial
stability, are vital for supporting economic growth. This will require rebuilding key financial
markets—such as securitization—on a sounder basis. At the same time, preventing andprotecting against future crises will be essential, but more comprehensive solutions areneeded—notably, how to limit the systemic risk posed by large financial institutions.
The pattern of global demand will need to be rebalanced along two key margins.
To sustain solid global growth, the sources of demand will need to shift from thepublic sector to the private sector, particularly in advanced economies with highpublic debt. To achieve sustainable public finances, substantial fiscal consolidation
once the recovery is established will critically require entitlement reform.

Second, a shift from internal to external demand in external deficit countries hit bypronounced credit and housing cycles, matched by counterpart adjustments insurplus countries that have been heavily reliant on export-led growth will be
important. Impediments could stand in the way of further rebalancing global
demand.

Successful global rebalancing will require a concerted multilateral policy effort. Alongsidepublic and private balance sheet repair in major deficit countries, structural reform efforts
will be key to boost domestic spending in major surplus countries. Exchange rate
appreciation in key surplus countries (depreciation in deficit countries) may be needed forrebalancing.
Finally, addressing rising unemployment will be an important policy challenge. Facilitating
the reabsorption of workers displaced by the crisis can be achieved through programs
assisting job search, matching, and retraining.

Sustaining solid global growth in the aftermath of the financial crisis will be a fundamental
challenge due to the impact of the crisis on balance sheets and, possibly, productive
potential. A framework for achieving sustainable growth should contain the following
essential elements—full repair of the financial system and rebalancing the sources of globaldemand. Restoring efficient intermediation and innovation in the financial system, whilesafeguarding financial stability, will be vital for supporting economic growth. Second, thesources of global demand will need to be rebalanced—from public to private sector demand,and from internal to external demand in major external deficit countries, matched bycounterpart adjustments in major surplus countries. Successful global rebalancing will
require a concerted multilateral policy effort.
I. POTENTIAL OUTPUT AFTER THE CRISIS AND POLICY CHALLENGES
1.
The crisis may have damaged potential output through several channels.
Declines in capital formation, substantial and protracted increases in unemployment, anddisruptions to the financial system all could weigh on
Output Losses After Banking Crises
future growth. The output effects are likely to be most(in percent; deviation from pre-crisis trend)
10
severe in those G-20 economies directly hit by banking
5crises.
0-5



-10
Experience over the last 40 years indicates that-15
output losses in the aftermath of banking crises are-20
both sustained and significant. As shown in the chart,-25-30GDP per capita 7 years after the start of the crisis-101234567tends to be about 10 percent lower (on average)
So urce: IM F staff estimates.
Figure repo rts mean difference fro m pre-crisis trend (o ver t-10 to tcompared to pre-crisis trends. However, country3); t-1no rmalized to 0; crisis begins at t=0. Shading indicates 90%
co nfidence interval fo r the mean (o range) and inter-quartile range
experiences vary widely around this, suggesting(yello w).
uncertainty about the impact of the current crisis andan instrumental role for policies. Specifically, past experience shows that growth
typically recovers in time, but the varied post-crisis output performance importantly
reflects key policy actions. 1

2.
Repairing the financial system and relying on supportive labor market policies
can mitigate the loss of output. Past experience suggests that reform measures that facilitate
resource reallocation, including the capacity to reabsorb displaced labor, tend to mitigate thelarge disruptive effects of crises on economic activity. To facilitate the reabsorption of
displaced workers, labor mobility would benefit from active labor market policies (ALMPs)
targeting job search, matching, and training programs. Measures to fix impaired financial
intermediation and damaged balance sheets that typically accompany crises also help reduce
losses to productivity and, thus, potential output.
1

For detailed analysis, see Chapter 4 of the World Economic Outlook (October 2009).

2
II. REMAKING THE FINANCIAL SYSTEM
3.
The future functioning of the financial system will be a key determinant ofglobal growth prospects. A healthy and dynamic financial system is crucial for efficientintermediation and innovation, which contributes to economic growth. New regulations andreforms must strike the right balance between rebuilding key financial markets in support ofgrowth, while effectively safeguarding against future threats to financial stability.
4.
Reducing the threat of future systemic crises is an essential element within aframework for sustainable growth. While plans are being developed to address the major
fault lines exposed by the financial crisis—in terms of private incentives and risk
management, financial regulations, and prudential oversight—reform momentum must not belost as market confidence recovers. Challenges to key reforms remain formidable to resolve
the deep flaws that led to a build-up of systemic risk. Progress is needed in the following
areas:
The perimeter of regulation should be broadened to cover all systemically importantinstitutions. This is crucial to close regulatory gaps, including the transfer of credit
risk to key financial institutions who had faced different regulatory requirements.

Prudential frameworks must play a greater stabilizing role over the business cycle.
This is needed to avoid the build-up of financial vulnerabilities seen during the boom
phase and the fire sales and abrupt deleveraging that amplified the subsequent crisis.

Better mechanisms are needed to deal with institutions that are “too big or tooconnected to fail,” but comprehensive solutions are sorely lacking. Proposals torequire systemic institutions to develop resolution plans and to hold supplemental
capital to compensate for their larger contribution to systemic risk should help, butpreventive measures alone are not sufficient to effectively contain financial fallout if
another major bankruptcy were to occur. Stronger crisis resolution mechanisms arealso needed. Sound compensation policies (without arbitrary caps) that reward longterm objectives of the firm is also key for maintaining the right incentives to avoid
excessive risk taking.

International coordination should be strengthened and financial protectionism should
be avoided. This effort will require greater supervisory and regulatory cooperationand convergence across many agencies and jurisdictions. Multilaterally consistentbank-specific resolution frameworks at the national level will be needed to resolve
cross-border firms and to counter incentives for beggar-thy-neighbor approaches.

5.
Rebuilding key financial markets on a sounder basis would strengthen growthprospects. Securitization—where markets remain essentially closed or heavily dependent on
public support—needs to be rebuilt to deliver on its promise to transfer and disperse credit
risks from the banking system to capital markets. To repair incentive and information

3
problems that led to the collapse of securitization markets, accounting standards anddisclosure should be strengthened all along the chain of intermediation, products should besimplified and standardized, and incentives for issuers and rating agencies should berealigned. Policies are generally moving in the right direction, including to require more“skin in the game” from issuers, but proposals need to be carefully calibrated to avoid stiflingmarket activity. 2
III. GLOBAL REBALANCING AND POLICY CHALLENGES
6.
Required balance sheet repair after the crisis needs to be accompanied by a shift
in the sources of global demand to sustain growth. Several G-20 economies face a lengthy
period of substantial balance sheet adjustment—particularly in countries with large public
and external deficits and affected by large credit and housing booms and busts. Specifically:As the recovery takes hold, public sector
accounts will need to be consolidated
considerably to achieve fiscal sustainability,
restraining public demand. Following
exceptional public actions taken to stabilize thefinancial system and to support aggregate
demand, substantial efforts over many years will
be needed to reverse the deterioration ofbudgetary positions and place public debt onto
sustainable trajectories, particularly in the many
economies with high public debt.3 The amount ofadjustment needed would be even larger ifgrowth is weaker over the medium term. This
adds to the enormous fiscal burdens related topopulation aging—which dwarfs the costs
incurred from the crisis— and will require major
entitlement reform to safeguard public finances.

Outlook for Public Finances(Percent of GDP)2

Fiscal Balance

0-2-4-6G-20-8G-20 (Advanced)-10

G-20 (Emerging)-1200

02040608

101214Source: IMF, World Economic Outlook.

U.S. Household
Savings
Current
WEO Ratio(Percent of disposable income)9876Household balance sheets will also need to bestrengthened, implying higher private saving. Inthe United States, household debt remains at
historic highs, while financial and housing
wealth have suffered steep losses, alongside

543
2
1000

020406081012So urce: IM F, Wo rld Eco no mic Outlo o k.

23For detailed analysis, see Chapter 2 of the Global Financial Stability Report (October 2009).

For a detailed discussion of exit strategies and fiscal adjustment, see Global Economic Prospects and Policy
Challenges, IMF Surveillance Note for the G-20 meeting of Ministers and Deputies, September 3-4, 2009.

144weaker growth prospects and rising unemployment. Moreover, perceived
macroeconomic and financial risks are higher. This indicates that the recent sharp
recovery in U.S. household saving rates will need to be sustained or even extended.
Other advanced economies—e.g., United Kingdom, Ireland, and Spain—and someemerging economies (especially in Europe) will also need to see significant
consolidation of household finances in the wake of major housing and credit busts.
Repair in public and private sector balance sheets imply shifts in the underlying
pattern of saving and investment. Specifically, higher saving (net of investment) andsmaller current account deficits are likely among many G-20 advanced economies.
Similar adjustment patterns are likely in much of emerging Europe, amid tighter
external financing conditions.

7.
Following the crisis, the recovery in many advanced economies will need todepend more on net exports, matched by less dependence elsewhere. With damaged
balance sheets and interests rates at the floor, domestic demand in countries directly hit bythe crisis will be constrained for some time. This suggests that countries such as the UnitedStates will need to rely more on foreign demand and higher net
Global Imbalances
exports to support growth. As the counterpart, lower net exports(Percent of World GDP)
USOIL
CHN
GER
are needed elsewhere to reallocate the pattern of global demand
EMAROW
GIPS
UKand to sustain the global recovery. For example, emergingeconomies (notably, in Asia) would have to become less reliant
on export-led growth and more reliant on domestic demand.
Advanced economies such as Japan and Germany, as well as oil
exporters, could also support rebalancing through desirable
reforms that strengthen growth prospects from domestic sources.
statistical discrepancy

JPN
CEE
32
1
0-1-2-3
8.
Factors that may impede this rebalancing would need
96 98 00 02 04 06 08 10 12 14
So urce: IM F staff estimates.
to be addressed. Global imbalances have narrowed sharply after
the crisis, reflecting some painful corrections and cyclical factors(see chart).4 However, imbalances—based on current policy trajectories—are projected towiden again, signaling the need for further underlying adjustment. A number of distortions
keep saving high in key surplus countries; and problems with the international monetarysystem continue to prompt self insurance in some countries through large reserve
accumulation, especially after the crisis.

4As shown in the chart, US and UK current account deficits and those in other advanced countries (Greece,Ireland, Portugal, Spain (GIPS)) and emerging Europe (CEE) have narrowed sharply, as credit and housing
booms have turned to busts. Germany (GER) and Japan’s (JPN) external surpluses have noticeably narrowed,
alongside falling exports and manufacturing; while surpluses have diminished for oil exporters (OIL). Emerging
Asia (EMA)—notably, China—has seen less adjustment in its external positions.

59.
Successful rebalancing of global demand will thus require more forceful action,
including structural policies in both advanced and emerging economies. Rapid progress
toward fixing the financial system is essential to support productivity and growth inadvanced economies. In addition:
Given weaker growth prospects in key trading partners, emerging Asia (notably,China) should step up structural efforts. This includes financial reforms to improveaccess to credit for smaller enterprises and households to boost domestic spending.
Recent signs have been encouraging. Also, strengthening social safety nets, as well as
pension and healthcare systems, are instrumental for reducing precautionary saving.

Structural reform efforts to boost productivity in the non-tradables sector in key
surplus countries could enhance domestic growth prospects and facilitate a shift indemand toward the domestic economy. Major advanced economies with sizeable
external surpluses and lagging productivity in key sectors (notably, Germany andJapan) stand to gain. In emerging Asia, where services have tended to fall behindmanufacturing in terms of productivity catch-up, reforms aimed at liberalizing service
services would also be beneficial.

10.
Exchange rate appreciation in key surplus countries and depreciation in deficit
countries may be needed. To facilitate adjustment in those economies that need to rely lesson external demand and to maintain output at potential, exchange rate appreciation would
encourage a shift in productive resources from tradable to nontradable sectors. Stronger
currencies (in real terms) would also boost purchasing power and consumption in key surplus
countries. As the counterpart, depreciating currencies in major deficit countries would
facilitate adjustment away from domestic demand toward net exports. To promote greater
exchange rate flexibility in some countries, strengthened country insurance and multilateralliquidity provision could help limit incentives for reserve accumulation that, along withinflexible exchange rates, has been a feature of export-led growth strategies in the past.
11.
Joint implementation of policies in key surplus and deficit countries to advance
rebalancing would strengthen global growth prospects.5 Staff analysis suggests thatstrong pursuit of these policy actions would bolster global growth and promote gradualmovement towards rebalancing in current account positions. Unsuccessful or misguidedpolices present a downside risk, where rebalancing is limited and growth is lower. With slow
progress on key policies (including repair of the financial system) and a drift toward
protectionist measures, growth could be appreciably lower.6
5The main policies for rebalancing are consistent with recommendations and policy plans highlighted in theMultilateral Consultations on Global Imbalances. See http://www.imf.org/external/np/pp/2007/eng/062907.pdf .
6See Global Economy Beyond the Crisis—Challenges Over the Medium Term, IMF Surveillance Note for theG-20 Meetings of Ministers and Deputies, September 3-4, 2009.