The world economy has entered new and precarious territory. The U.S. economy continues to be mired in the financial problems that fi rst emerged in subprime mortgage lending but which have now spread much more broadly. Strains that were once thought to be limited to part of the housing market are now having considerable negative effects across the entire economy, with rising defaults, falling collateral, and tighter credit working together to create a powerful and hard-to-defeat financial decelerator.

In addition to serious problems at the intersection of credit and the real economy, the United States remains plagued by profound errors in risk management among its leading financial institutions. Problems that were once thought to be limited to issues surrounding liquidity in short-term money markets—and thought capable of being dealt with as such— have cascaded across much of the financial sector, triggering repeated waves of downgrades, upward adjustment of losses for both U.S. and European banks, and now an apparently unstoppable move toward some significant degree of global deleveraging.

This cutback in lending and the associated attempt to reduce risks played a major role in a most dramatic pair of events—both of which happened as this World Economic Outlook entered its fi nal stages of preparation. First, one of the fi ve largest U.S. investment banks, Bear Stearns, was sold under diffi cult circumstances—including the presumed imminence of a far-reaching default. Second, and just as headline-grabbing, were the virtually unprecedented steps taken by the Federal Reserve to prevent Bear Stearns’s problems from spreading. These steps have had a definite stabilizing effect, at least for now.

The effects on the rest of the world are likely to be signifi cant. We have already reduced our expectations for growth in Europe and much of the emerging world. Our revised global growth forecast is 3.7 percent, down from 4.9 percent in 2007, which represents a pronounced slowdown.

However, I would stress that achieving growth even at this level will require that most advanced economies experience only mild slowdowns and that many emerging economies be able to keep their rapid pace of growth largely on track.

In addition to problems within the financial sector, there are two main short-run vulnerabilities for the global economy, both of which are covered in considerable detail in this World Economic Outlook. The first is that housing prices may adjust downward signifi cantly in many other advanced economies (fi rst fi gure). Although Chapter 3 shows that the particular dynamics of the housing market in the United States are not matched by those in other countries, it also shows that housing may now play a more marked role in the business cycle more broadly—as the nature of mortgage financing has changed and as valuations have increased almost everywhere over the past 10 years.

The second potential vulnerability is, of course, commodity prices. Chapter 5 examines the role of commodity prices in contributing to the strong performance of many emerging and developing economies in recent years. It is striking how the surging tide of commodity prices over the past five years (second figure) has lifted almost all commodity-based boats around the world.

Although there is some reason to believe that the countries exporting commodities are now better able than in the past to withstand a serious downturn, we continue to urge caution: commodity prices have fallen, on average, by 30 percent during signifi cant global slowdowns over the past 30 years. ...

Visit World Economic Outlook 2008: Housing and the Business Cycle Web Page

The World Economic Outlook (WEO) presents the IMF staff's analysis and projections of economic developments at the global level, in major country groups (classified by region, stage of development, etc.), and in many individual countries.

It focuses on major economic policy issues as well as on the analysis of economic developments and prospects. It is usually prepared twice a year, as documentation for meetings of the International Monetary and Financial Committee, and forms the main instrument of the IMF's global surveillance activities.

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Outlook and Risks

Global growth is projected to slow to 3.7 percent in 2008, ½ percentage point lower than at the time of the January World Economic Outlook Update and 1¼ percentage points lower than the growth recorded in 2007. Moreover, growth is projected to remain broadly unchanged in 2009. The divergence in growth performance between the advanced and emerging economies is expected to continue, with growth in the advanced economies generally expected to fall well below potential.

The U.S. economy will tip into a mild recession in 2008 as the result of mutually reinforcing cycles in the housing and fi nancial markets, before starting a modest recovery in 2009 as balance sheet problems in financial institutions are slowly resolved (Chapter 2). Activity in western Europe is also projected to slow to well below potential, owing to trade spillovers, financial strains, and negative housing cycles in some countries. By contrast, growth in emerging and developing economies is expected to ease modestly but remain robust in both 2008 and 2009. The slowdown refl ects efforts to prevent overheating in some countries as well as trade and fi nancial spillovers and some moderation in commodity prices.

The overall balance of risks to the short-term global growth outlook remains tilted to the downside. The IMF staff now sees a 25 percent chance that global growth will drop to 3 percent or less in 2008 and 2009—equivalent to a global recession. The greatest risk comes from the still-unfolding events in fi nancial markets, particularly the potential for deep losses on structured credits related to the U.S. subprime mortgage market and other sectors to seriously impair financial system balance sheets and cause the current credit squeeze to mutate into a full-blown credit crunch.

Interaction between negative financial shocks and domestic demand, particularly through the housing market, remains a concern for the United States and to a lesser degree for western Europe and other advanced economies. There is some upside potential from projections for domestic demand in the emerging economies, but these economies remain vulnerable to trade and financial spillovers.

At the same time, risks related to inflationary pressures have risen, reflecting the price surge in tight commodity markets and the upward drift of core inflation.

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