The International Monetary Fund says the near-term fate of the global economy will be determined by policy makers in Europe and the U.S., an uncomfortable prospect given the recent performance of politicians in capitals such as Berlin, Madrid and Washington.
Global economic growth has lost considerable momentum since a sharp rebound from the financial crisis in 2010, as the euro zone debt crisis turned into a recession and political gridlock in the U.S. left the Federal Reserve to support the recovery without an assist from fiscal policy.
The IMF said Monday that the world economy will expand 3.9 per cent in 2013, compared with an estimate of 4.1 per cent in April, as a shallow economic contraction in the euro area diminishes global trade and uncertainty about future tax and regulatory policy undermines confidence in the United States.
Europe's struggles are the primary cause of the world's economic decline, and resolving the crisis that has dragged on for three years is the "utmost priority," the IMF said in an update to its World Economic Outlook.
In 2010, global GDP expanded 5.3 per cent, after contracting in 2009. After a promising start this year, the global economy has deteriorated steadily from the second quarter, and the IMF now sees little chance of that momentum returning any time soon. The greater risk, however, is that politicians and central bankers might fail to keep things from getting even worse.
"Downside risks continue to loom large, importantly reflecting risks of delayed or insufficient policy action," the fund said.
The faltering global economy is limiting Canada's prospects by crimping global trade and reducing commodity prices. The IMF predicted the average of crude prices derived in London, Dubai and New York will decline 2.1 per cent in 2012 after surging by about 30 per cent in each of the previous two years.
That means lower profits for Alberta's oil patch – and potentially less investment and hiring. The fund left its outlook for Canada's growth essentially unchanged at 2.1 per cent this year and 2.2 per cent in 2013.
In Europe, Italy and Spain – the third- and fourth-biggest economies in the euro zone – are facing significant recessions that will stretch into 2013, according to the IMF. The combined GDP of all 17 users of the euro will contract 0.3 per cent in 2012 and rebound by only 0.7 per cent next year, the IMF said.
Recent decisions by European leaders to use their rescue fund to stabilize banks in Spain and create a single supervisor for the region's biggest lenders hold promise, the IMF said. But there is more to do, including structural changes that would boost economic growth and a pan-European deposit insurance guarantee.
The European Central Bank also has room to further ease monetary policy, the IMF said. The ECB two weeks ago dropped its benchmark lending rate a quarter-point to 0.75 per cent, the lowest ever, and told lenders it would no longer pay interest on deposits, a measure meant to prod bankers to lend rather than seek shelter at the central bank.
Another worry is Washington, where Republican and Democratic lawmakers show little sign they will soon resolve the "fiscal cliff," a combination of tax increases and spending cuts worth more than $600-billion (U.S) that are legislated to take effect in 2013. That amounts to a fiscal contraction equal to 4 per cent of GDP, which would be the biggest in four decades, said Hamilton Place Strategies, a Washington-based advisory firm.
The U.S. must narrow its deficit: Last year, Washington spent 24.1 per cent of GDP and collected only 15.4 per cent of GDP in revenue, compared with historical averages of 19.7 per cent and 17.7 per cent respectively.
But the IMF says the U.S. economy is too weak to absorb the fiscal shock currently on the books. Failure to moderate spending and tax plans could cut U.S. growth by as much as 4 per cent – more than enough to cause a recession, Olivier Blanchard, the IMF's chief economist, told a press conference. A decline of that size in the world's largest economy would reduce global GDP by 1.5 per cent.
"We are talking possibly an enormous shock," Mr. Blanchard said. "If this were to happen, it would be a major, major event."