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Capsule summary of downside risks to the global economy [ClearOnMoney]
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Capsule summary of downside risks to the global economy

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Commentary

Capsule summary of downside risks to the global economy

17 Apr 2012 by Jim Fickett.

Today the IMF released the completed spring World Economic Outlook. The introduction gives a pithy overview of risks to world economic growth:

The most immediate concern is still that further escalation of the euro area crisis will trigger a much more generalized flight from risk. This scenario, discussed in depth in this issue, suggests that global and euro area output could decline, respectively, by 2 percent and 3 1⁄2 percent over a two-year horizon relative to WEO projections. Alternatively, geopolitical uncertainty could trigger a sharp increase in oil prices: an increase in these prices by about 50 percent would lower global output by 1 1⁄4 percent. The effects on output could be much larger if the tensions were accompanied by significant financial volatility and losses in confidence. Furthermore, excessively tight macroeconomic policies could push another of the major economies into sustained deflation or a prolonged period of very weak activity. Additionally, latent risks include disruption in global bond and currency markets as a result of high budget deficits and debt in Japan and the United States and rapidly slowing activity in some emerging economies.

Or, even more concisely:

  • Euro debt crisis; Europe recession
  • Iran war
  • Japan or US debt crisis
  • China hard landing

The direct economic effects from a recession in Europe on the US are likely to be small:

Here is the IMF's overview of their estimated effect on economies around the world if the euro crisis worsens:

(Click for larger image.)

What is much less clear than the economic linkages are the financial linkages. One can quantify the overall financial claims,

but it remains very unclear whether there are dangerous concentrations of claims at particular institutions, so that there remains some risk of a financial crisis spreading from European banks to those of other countries.

during periods of intense financial stress, such as after the bankruptcy of Lehman Brothers in 2008, financial spillovers could strengthen. …

Fire sales of assets can spread across banks, potentially leading to a vicious circle of selling and price declines. Large divestiture by foreign affiliates can substantially weaken financial institutions’ equity prices, as was the case recently in Latin America.