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International Economic UpdateDecember 23, 2008The Slowdown MaterializesThe financial crisis that began in the North Atlantic region has morphed into a global slowdown. Financial markets remain tense despite efforts to increase liquidity. Growth around the world is expected to remain negative into 2009 (Chart 1). The lower demand is causing a decline in inflation, as well as in trade. A rebound to the global economy is expected by the end of 2009.
Financial markets have shown a modest improvement since October. Central banks have been aggressively cutting policy rates and taking other measures to inject liquidity into the markets (Chart 2). More cuts are expected early next year to help ease financial stress. The LIBOR-OIS spread, which measures the rate premium banks charge each other over the policy rate, has come down some since its peak in October, but remains considerably higher than pre-September levels (Chart 3). Moderate improvements have also been seen in stock market volatility and in credit default swap (CDS) spreads for major commercial banks, suggesting that the markets are still nervous, but less so than a month ago.
Most G-7 economies officially entered into a recession in third quarter 2008 (as seen earlier in Chart 1). The euro-area and the U.K. economies have been hit hard by the financial crisis. Policymakers are implementing fiscal policy to stimulate demand. The French (€26 billion) and the Germans (€12 billion) have already announced stimulus plans that include spending on infrastructure and business tax credits. The U.K. has also announced a plan (£20 billion) that includes dropping the value-added tax rate from 17.5 percent to 15 percent until 2010. The Japanese economy, meanwhile, is being hurt by a slowdown in its export industry. A slowdown in demand among its trade partners, as well as a 33.8 percent appreciation of the yen against a broad basket of currencies since August, has combined to drive down exports [1]. Exports in developing countries are expected to decline as well. They are affected by the slowdown in global demand, but exporting firms are also finding it difficult to obtain the necessary financing. Developing economies have been highly reliant on trade to fuel economic growth. For that reason, there is speculation that some may enact trade policies in order to boost exports and restrict imports. While most developing economies are not expected to enter into a recession, they are expected to see their growth fall below trend. Inflation expectations have declined considerably around the world (Chart 4). The slowdown in global demand has caused a steep decline in commodity prices. As commodity prices have fallen, particularly oil, the inflation outlook has improved. This development has allowed monetary policy makers to focus efforts on restoring financial stability and stimulating demand.
The United States, like the rest of the world, is seeing a decline in exports. This is driven by weakened demand from our trade partners, but also by the appreciation of the U.S. dollar [2]. The decline is most notable in the capital goods and the industrial supplies sectors, which collectively make up 47 percent of our total exports (goods and services) and declined 13 percent from July to October. Chart 5 shows the decline since July in both exports and imports. While this has caused a modest increase in the nominal trade balance in October, the result was much more negative for the real trade balance.
How quickly the financial markets and the real economy respond to monetary and fiscal stimulus should determine how quickly we recover from the slowdown. Analysts project a recovery by the end of 2009. The recovery may take more time if financial markets take longer to improve, demand remains sluggish in the advanced economies or growth is weaker than expected in the developing economies. However, if liquidity is restored quickly to the system and consumer confidence is restored, we may see signs of an improvement much sooner. —Patrick Roy About the AuthorRoy is a research analyst in the Research Department at the Federal Reserve Bank of Dallas. Notes
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