As mentioned elsewhere in this paper, due to high debt levels and certain structural rigidities, the Eurozone and the US are likely to experience lower than trend growth and productivity gains and relatively high unemployment rates over the medium-term. The likely macroeconomic response by these countries, particularly continuing their loose monetary policy stance for domestic reasons, is likely to cause further volatility in capital flows and exchange rates over the next few years, with the US growth projected to be in the range 2 to 2.5 percent, and Japan in the 1.5 to 2 percent, and Europe experiencing a mild red recession in 2012 and likely to recover only slowly. As a result, advanced economies as a group are now expected to grow in the range of 1.5 to 2 percent over the next few years. This will be substantially below these countries average trend growth of about 2.5 to 3 percent.<sup>54</sup> Emerging economies (and the rest of the developing countries) are projected to grow in the range 5.5 to 6 percent a year.55 The more rapid growth of the emerging economies than the advanced economies is likely to accelerate the rise in economic weight of emerging economies, thus further solidifying the multi-polar growth structure of the global economy.

The U.S. economy continues to slowly recover from its worst financial crisis since the Great Depression, aided by highly expansionary fiscal and monetary policies. Monetary policy during the post crisis period has remained highly accommodative, with policy rates near zero and a significantly expanded Federal Reserve balance sheet. While the financial system continues to strengthen, lending conditions remain very tight for some segments of the economy. Household balance-sheet remains weak and house prices have continued their decline. These, together with high unemployment rates, have held down the growth of private consumption and new housing construction. Moreover, corporate spending and hiring have remained relatively weak, despite record-high profit growth and easy financing conditions for large firms. Therefore, while the US authorities’ macroeconomic policy stance is sensible from the domestic stability point of view, given the size of the US economy and its strong financial and trade linkages with the rest of the world, these policies have major spillover effects on the rest of the world. One the one hand, the US recovery has supported the global economic recovery, particularly through the trade channel. On the other hand, the financial spillover effects, particularly through the massive liquidity injections and near zero interest rates, have had more complex implications for the rest of the world.

According to recent IMF research, lower real US interest rates and higher real world GDP growth rates have been associated with “a higher probability of capital inflow surge in emerging market

> 54 Both recent World Economic Outlook and Global Economic Prospects projections from the IMF and World Bank respectively support this view.  The main reason is the escalating eurozone crisis, due mainly to serious concerns about the region’s banking sector losses and fiscal sustainability.  Sovereign spreads for many eurozone countries widened sharply, reaching highs not seen since the launch of the region’s Monetary Union.  Bank funding dried up, which forced the European Central Bank to offer a three-year “Refinancing Operation.”  As a result, bank lending deteriorated in a number of countries in the region, and capital flows to developing countries experienced sharp declines.  Currency markets were highly volatile, as the Japanese yen, the swiss franc appreciated and most developing countries currencies depreciated significantly. Price of gold reached record highs.  The main characteristics of the global economy in the medium-term are expected to be as follows: (i) The overall economic activity in the advanced economies is projected to grow quite slowly (1.5 percent or less) in the next two years and continue to experience high unemployment; (ii) The eurozone is already experiencing a recession and could experience further difficulties due to the rise of sovereign yields, the effects of bank deleveraging on the real economy, and the impact of additional fiscal consolidation announced by euro area governments; and (iii) With highly constrained macroeconomic policies, growth in most advanced economies is likely to be lower, mainly due to adverse spillovers from the euro area via trade and financial channels that exacerbate the effects of existing weaknesses. For the United States, the growth impact of such spillovers is broadly offset by stronger underlying domestic demand dynamics in 2012. Nonetheless, activity slows from the pace reached during the second half of 2011, as higher risk aversion tightens financial conditions and fiscal policy turns more contractionary. 55 See World Bank (2012).

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