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Tim Colebatch
April 17, 2009

AMID rising optimism that the global financial crisis could end sooner than expected, the International Monetary Fund has issued a new warning that the crisis is likely to be “unusually long and severe” and followed by only a “sluggish” recovery.

An analysis of past recessions in Western countries prepared for the IMF’s half-yearly World Economic Outlook, concludes that this recession, unlike those in recent decades, has several features that are likely to make it deeper and more protracted than normal.

The analysis, released overnight, finds that:

*Recessions that stem from financial crises endure longer and go deeper than those with their roots in macro-economic problems.

*Recessions that engulf the world last longer and are followed by weaker recoveries than those restricted to a single country.

*Counter-cyclical monetary policy is largely ineffective in tackling a financial crisis, but expansionary fiscal policy “seems particularly effective in shortening recessions associated with financial crises, and (in) boosting recoveries”.

*Developing countries are likely to face problems in accessing finance even after recovery sets in, as the new fear of risk among global investors will fade only slowly.

The fund’s warnings come after US President Barack Obama sought to rally American morale by talking of “glimmers of hope” in the US economy, while markets globally have enjoyed a sustained rally, raising hopes that the crisis might end sooner than expected.

It also comes as China reported a surprisingly strong rebound in investment in the cities, both in infrastructure and in property development.

The IMF analysis, commissioned well before any of these events, was released in advance of the half-yearly meetings of the fund and the World Bank in Washington next week. The IMF will release its updated Global Financial Stability report on Tuesday and its new forecasts for the global economy on Wednesday. Finance ministers will meet the following weekend.

It notes that by the end of 2008, 15 of the 21 richest countries were already in recession, on the simple definition of two consecutive quarters of negative growth. The IMF says all Western countries, including Australia, will end up there.

“The results (of this analysis) suggest that recessions associated with financial crises tend to be unusually severe, and their recoveries typically slow,” it concluded.

The IMF warned that “overleveraged economies” were unlikely to bounce back quickly through strong growth in domestic private demand, as they would require “a prolonged period of above-average saving”. It did not name them, but Australia is clearly one of them.

It again spelt out the case for a strong fiscal policy response, with the Government acting as the “spender of last resort” to break the negative feedback between weaknesses in the financial sector and the real economy.

“Given the shortfalls in both domestic private demand and external demand, policy must be used to arrest the cycle of falling demand, asset prices, and credit,” the IMF argued. “However, evidence indicates that interest rate cuts are likely to have less of an impact during a financial crisis … (whereas) fiscal policy can make a significant contribution to reducing the duration of recessions associated with financial crises.”

But even with “coherent and comprehensive action”, it concluded, “recovery is likely to be slow and relatively weak”.

http://business.theage.com.au/business/recession-to-be-long-and-severe-20090416-a8w6.html

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