World Economic Outlook, April 2008 World Economic Outlook Housing and the Business Cycle World Economic Outlook Housing and the Business Cycle World Economic and Financial Surveys INTERNATIONAL MONETARY FUND 08 APR IMF APR 08 WORLD ECONOMIC OUTLOOK April 2008 Housing and the Business Cycle International Monetary Fund World Economic and Financial Surveys ©2008 International Monetary Fund Production: IMF Multimedia Services Division Cover and Design: Luisa Menjivar and Jorge Salazar Figures: Theodore F. Peters, Jr. Typesetting: Choon Lee Cataloging-in-Publication Data World economic outlook (International Monetary Fund) World economic outlook : a survey by the staff of the International Monetary Fund. — Washington, DC : International Monetary Fund, 1980– v. ; 28 cm. — (1981–1984: Occasional paper / International Monetary Fund, 0251-6365). — (1986– : World economic and financial surveys, 0256-6877) Semiannual. Has occasional updates, 1984– 1. Economic history, 1971–1990 — Periodicals. 2. Economic history, 1990– — Periodicals. I. International Monetary Fund. II. Series: Occasional paper (International Monetary Fund). III. Series: World economic and financial surveys. HC10.W7979 84-640155 338.5’443’09048—dc19 AACR2 MARC-S ISBN 978-1-58906-719-6 Subscription price (published twice yearly): $94. Individual report price: $57 (academic rate: $54). Please send orders to: International Monetary Fund, Publication Services 700 19th Street, N.W., Washington, D.C. 20431, U.S.A. Tel.: (202) 623-7430 Telefax: (202) 623-7201 E-mail: publications@imf.org www.imf.org iii CONTENTS Assumptions and Conventions viii Preface x Foreword xi Executive Summary xiv Chapter 1. Global Prospects and Policies 1 Overview of Recent Developments and Prospects: Divergence but Not Decoupling 1 Financial Market Turbulence: Rocky Ride for the Advanced Economies 4 Can Emerging and Developing Economies Decouple? 22 Outlook and Risks for the Global Economy 30 Policy Challenges in a Multipolar World 38 Appendix 1.1. Implications of New PPP Estimates for Measuring Global Growth 43 Appendix 1.2. Commodity Market Developments and Prospects 46 References 62 Chapter 2. Country and Regional Perspectives 65 United States and Canada: How Long Will the Slowdown Last? 65 Western Europe: Can a Sharp Slowdown Be Averted? 75 Advanced Asia: How Resilient Is Growth in Japan to a Global Slowdown? 78 Emerging Asia: Strong Internal Momentum, but Rising Risks from Spillovers 80 Latin America and the Caribbean: Facing a Cold North Wind 82 Emerging Europe: Adjusting to a Rougher External Environment 85 Commonwealth of Independent States: Containing Infl ation Remains the Central Challenge 88 Sub-Saharan Africa: Strong Growth Prospects, but Risks Remain 94 Middle East: Infl ation Is a Growing Concern 97 References 99 Chapter 3. The Changing Housing Cycle and the Implications for Monetary Policy 103 Developments in Housing Finance 104 The Housing Sector and the Business Cycle 107 Housing Finance and Spillovers from Housing 110 Housing Finance and Housing as a Transmission Channel for Monetary Policy 117 Should Changes in the Housing Cycle Affect the Conduct of Monetary Policy? 122 Conclusions 126 Appendix 3.1. Data and Methodology 128 References 130 CONTENTS iv Chapter 4. Climate Change and the Global Economy 133 How Will Climate Change Affect Economies? 134 How Can Countries Best Adapt to Climate Change? 147 How Can Countries Effectively and Effi ciently Mitigate Climate Change? 155 Conclusions 173 Appendix 4.1. The G-Cubed Model, Baseline Assumptions, and Other Models in the Climate Change Literature 175 References 184 Chapter 5. Globalization, Commodity Prices, and Developing Countries 191 Commodity Prices and Patterns of Integration 197 Globalization and Commodity Price Cycles 205 Explaining the Patterns 210 Conclusions 213 Appendix 5.1. Data and Methodology 215 References 220 Annex: IMF Executive Board Discussion of the Outlook, March 2008 223 Statistical Appendix 229 Assumptions 229 What’s New 232 Data and Conventions 232 Classifi cation of Countries 234 General Features and Composition of Groups in the World Economic Outlook Classifi cation 236 List of Tables 240 Output (Tables A1–A4) 241 Infl ation (Tables A5–A7) 249 Financial Policies (Table A8) 255 Foreign Trade (Table A9) 256 Current Account Transactions (Tables A10–A12) 258 Balance of Payments and External Financing (Tables A13–A15) 264 Flow of Funds (Table A16) 268 Medium-Term Baseline Scenario (Table A17) 272 World Economic Outlook and Staff Studies for the World Economic Outlook, Selected Topics 273 Boxes 1.1 Is There a Credit Crunch? 9 1.2 Depreciation of the U.S. Dollar: Causes and Consequences 18 1.3 Multilateral Consultation on Global Imbalances: Progress Report 27 1.4 Dollar Depreciation and Commodity Prices 48 1.5 Why Hasn’t Oil Supply Responded to Higher Prices? 53 1.6 Oil Price Benchmarks 58 2.1 When Does Fiscal Stimulus Work? 70 CONTENTS v 2.2 Petrodollars and Bank Lending to Emerging Markets 89 3.1 Assessing Vulnerabilities to Housing Market Corrections 113 4.1 Rising Car Ownership in Emerging Economies: Implications for Climate Change 142 4.2 South Asia: Illustrative Impact of an Abrupt Climate Shock 144 4.3 Macroeconomic Policies for Smoother Adjustment to Abrupt Climate Shocks 148 4.4 Catastrophe Insurance and Bonds: New Instruments to Hedge Extreme Weather Risks 152 4.5 Recent Emission-Reduction Policy Initiatives 156 4.6 Complexities in Designing Domestic Mitigation Policies 160 5.1 How Does the Globalization of Trade and Finance Affect Growth? Theory and Evidence 194 5.2 The Current Commodity Price Boom in Perspective 198 A1 Economic Policy Assumptions Underlying the Projections for Selected Economies 230 Tables 1.1 Overview of the World Economic Outlook Projections 2 1.2 Shares of Global GDP, 2007 45 1.3 Global Oil Demand and Production by Region 51 1.4 Food, Fuel, and Headline Infl ation 62 2.1 Advanced Economies: Real GDP, Consumer Prices, and Unemployment 66 2.2 Advanced Economies: Current Account Positions 67 2.3 Selected Asian Economies: Real GDP, Consumer Prices, and Current Account Balance 82 2.4 Selected Western Hemisphere Economies: Real GDP, Consumer Prices, and Current Account Balance 83 2.5 Selected Emerging European Economies: Real GDP, Consumer Prices, and Current Account Balance 85 2.6 Commonwealth of Independent States (CIS): Real GDP, Consumer Prices, and Current Account Balance 93 2.7 Selected African Economies: Real GDP, Consumer Prices, and Current Account Balance 96 2.8 Selected Middle Eastern Economies: Real GDP, Consumer Prices, and Current Account Balance 98 3.1 Institutional Differences in National Mortgage Markets and the Mortgage Market Index 107 3.2 Abnormal Contributions to GDP Growth Weakness One Year before Recessions 110 3.3 Features of House Price Cycles 111 3.4 Forecast Variance Decomposition: Housing Demand Shocks—Average across Countries 117 3.5 Optimal Coeffi cients in the Taylor Rule 127 3.6 Estimates of the Error-Correction Model of Consumption 129 4.1 Losses in Real GNP, 2040 167 4.2 Baseline Growth Assumptions 178 4.3 Carbon-Based Emission Coeffi cients 179 4.4 Summary of the Baseline Scenario 180 4.5 Emission Intensities in the Baseline 181 4.6 Emission Reductions and Consumption Losses Following a Standardized Carbon Price Shock 182 CONTENTS vi 4.7 Comparison of Climate Policy Models 183 5.1 Cross-Sectional Regressions: Overall Trade 211 5.2 Cross-Sectional Regressions: Commodity Trade, Foreign Direct Investment (FDI) 212 5.3 Panel Regressions: Overall Trade 212 5.4 Panel Regressions: Commodity Trade, Foreign Direct Investment (FDI) 213 5.5 Panel Regressions: Institutions and Policies 214 Figures 1.1 Global Indicators 3 1.2 Current and Forward-Looking Indicators 4 1.3 Global Infl ation 5 1.4 Measures of Monetary Policy and Liquidity 6 1.5 Developments in Mature Credit Markets 7 1.6 Mature Financial and Housing Market Indicators 8 1.7 External Developments in Selected Advanced Economies 17 1.8 Emerging Economy Financial Conditions 23 1.9 External Developments in Emerging and Developing Economies 24 1.10 Growing Global Role of Emerging and Developing Economies 25 1.11 Global Outlook 31 1.12 Risks to the Global Outlook 32 1.13 Measures of the Output Gap and Capacity Pressures 34 1.14 Current Account Balances and Net Foreign Assets 35 1.15 Two Scenarios for the Global Economy 37 1.16 Purchasing-Power-Parity (PPP) Exchange Rate Revisions and Global Growth 44 1.17 Commodity and Petroleum Prices 47 1.18 World Oil Market Balances 52 1.19 Energy and Metal Prices and Metal Consumption Growth 57 1.20 Recent Developments in Major Food Crops 60 1.21 Macroeconomic Implications of High Commodity Prices 61 2.1 United States: Housing Cycles in Perspective 67 2.2 Western Europe: Tightening Lending Standards 77 2.3 Japan: Will Domestic Demand Be Able to Support Growth? 79 2.4 Emerging Asia: Trade Patterns and Growth Developments 81 2.5 Latin America: Long Road to Stronger Performance 84 2.6 Emerging Europe: Macroeconomic Vulnerabilities on the Rise 87 2.7 Commonwealth of Independent States (CIS): Infl ation Pressures Remain the Central Concern 94 2.8 Sub-Saharan Africa: Vulnerability of Commodity Exports to Global Demand 95 2.9 Middle East: Strong Growth, Rising Infl ation 99 3.1 Mortgage Debt and Financial Innovation 105 3.2 Correlation of Real House Prices and Real Residential Investment with the Output Gap 108 3.3 Labor Market Characteristics and the Contribution of Residential Investment to the Business Cycle 111 3.4 Mortgage Market Index, Consumption and House Price Correlation, and the Long-Run Marginal Propensity to Consume out of Housing Wealth 112 3.5 Share of Output Variation Explained by Housing Demand Shocks 117 CONTENTS vii 3.6 Correlation between the Shares of Output and Housing Sector Variation Explained by Housing Demand Shocks 118 3.7 Correlation between the Share of Output Variation Explained by Housing Demand Shocks and the Mortgage Market Index 119 3.8 Housing and the Monetary Transmission Mechanism 119 3.9 Effect of Monetary Policy Shocks on Output and Housing Sector Variables in the United States 120 3.10 Elasticity of Real Residential Investment, Real House Prices, and Output to a 100-Basis-Point Increase in Short-Term Interest Rates 121 3.11 Interest Rate Elasticity of Real Residential Investment, Real House Prices, and Output and the Mortgage Market Index 122 3.12 Monetary Policy Counterfactuals 123 3.13 Macroeconomic Model with Housing as Collateral: Responses of Output and Consumption to Shocks for Different Loan-to-Value (LTV) Ratios 125 3.14 Macroeconomic Model with Housing as Collateral: Response of Nominal Interest Rates to a Positive Housing Demand Shock and a Negative Financial Shock for Various Loan-to-Value (LTV) Ratios 126 4.1 Carbon Dioxide Energy-Related Emissions 135 4.2 Emission Forecasts 136 4.3 Mean GDP Losses at Various Levels of Warming 137 4.4 Damages from 2.5°C Warming by Region 138 4.5 Impact of Warming by Region and Sector 139 4.6 Physical Impact by 2080 140 4.7 Variation in Estimates of Damages from Climate Change 141 4.8 Weather Derivatives and Catastrophe Bonds 151 4.9 Global Emission Targets and Paths, 1990–2100 164 4.10 Uniform Carbon Tax, 2013–40 165 4.11 Total Costs of Mitigation, 2013–40 166 4.12 Cap-and-Trade System, 2013–40 169 4.13 International Transfers under the Cap-and-Trade System 170 4.14 Cap-and-Trade System for All Regions Based on Share of World Population, 2013–40 171 4.15 Global Emissions from Energy Only, 2030 181 5.1 Trade in Goods and Services 191 5.2 Merchandise Exports of Emerging and Developing Economies 192 5.3 Gross Foreign Capital and Gross Foreign Liabilities 193 5.4 Commodity Prices 197 5.5 Values of Exports of Commodities and Manufactures 200 5.6 Volumes of Exports of Commodities and Manufactures 201 5.7 Patterns of Regional Trade 202 5.8 Foreign Direct Investment in Emerging and Developing Economies 203 5.9 Policy and Institutional Environment 204 5.10 Commodity Price Booms 205 5.11 Event Study of the Commodity Terms of Trade, 1970–2007 207 5.12 Explaining the Increase in Integration from the 1980s to the 2000s 214 A number of assumptions have been adopted for the projections presented in the World Economic Outlook. It has been assumed (1) that real effective exchange rates will remain constant at their average levels during January 30–February 27, 2008, except for the currencies participating in the European exchange rate mechanism II (ERM II), which are assumed to remain constant in nominal terms rela- tive to the euro; (2) that established policies of national authorities will be maintained (for specifi c assumptions about fi scal and monetary policies in industrial countries, see Box A1); (3) that the aver- age price of oil will be $95.50 a barrel in 2008 and $94.50 a barrel in 2009, and remain unchanged in real terms over the medium term; (4) that the six-month London interbank offered rate (LIBOR) on U.S. dollar deposits will average 3.1 percent in 2008 and 3.4 percent in 2009; (5) that the three-month euro deposits rate will average 4.0 percent in 2008 and 3.6 percent in 2009; and (6) that the six-month Japanese yen deposit rate will yield an average of 1.0 percent in 2008 and of 0.8 percent in 2009. These are, of course, working hypotheses rather than forecasts, and the uncertainties surrounding them add to the margin of error that would in any event be involved in the projections. The estimates and pro- jections are based on statistical information available through end-March 2008. The following conventions have been used throughout the World Economic Outlook: . . . to indicate that data are not available or not applicable; — to indicate that the fi gure is zero or negligible; – between years or months (for example, 2006–07 or January–June) to indicate the years or months covered, including the beginning and ending years or months; / between years or months (for example, 2006/07) to indicate a fi scal or fi nancial year. “Billion” means a thousand million; “trillion” means a thousand billion. “Basis points” refer to hundredths of 1 percentage point (for example, 25 basis points are equivalent to ¼ of 1 percentage point). In fi gures and tables, shaded areas indicate IMF staff projections. If no source is listed on tables and fi gures, data are drawn from the World Economic Outlook database. When countries are not listed alphabetically, they are ordered on the basis of economic size. Minor discrepancies between sums of constituent fi gures and totals shown are due to rounding. As used in this report, the term “country” does not in all cases refer to a territorial entity that is a state as understood by international law and practice. As used here, the term also covers some territo- rial entities that are not states but for which statistical data are maintained on a separate and indepen- dent basis. ASSUMPTIONS AND CONVENTIONS viii This report on the World Economic Outlook is available in full on the IMF’s website, www.imf.org. Accompanying it on the website is a larger compilation of data from the WEO database than in the report itself, consisting of fi les containing the series most frequently requested by readers. These fi les may be downloaded for use in a variety of software packages. Inquiries about the content of the World Economic Outlook and the WEO database should be sent by mail, electronic mail, or telefax (telephone inquiries cannot be accepted) to: World Economic Studies Division Research Department International Monetary Fund 700 19th Street, N.W. Washington, D.C. 20431, U.S.A. E-mail: weo@imf.org Telefax: (202) 623-6343 FURTHER INFORMATION AND DATA ix FURTHER INFORMATION AND DATA [...]...PREFACE The analysis and projections contained in the World Economic Outlook are integral elements of the IMF s surveillance of economic developments and policies in its member countries, of developments in international financial markets, and of the global economic system The survey of prospects and policies is the product of a comprehensive interdepartmental review of world economic developments,... considerations are those of the IMF staff and should not be attributed to Executive Directors or to their national authorities x FOREWORD This World Economic Outlook presents the IMF staff’s view of the world economy in spring 2 008, with our assessment of current conditions and prospects and with an in-depth analysis of several key elements that will affect conditions and prospects in the months and years ahead... slowdowns over the past 30 years All eyes now turn to the world s leading emerging economies They have come of economic age in the past half-decade—diversifying their exports, strengthening their domestic economies, and improving their policy frameworks It is conceivable that their strong momentum, together with some timely policy adjustments, can sustain both their domestic demand and the global economy... on information the IMF staff gathers through its consultations with member countries These consultations are carried out in particular by the IMF s area departments together with the Policy Development and Review Department, the Monetary and Capital Markets Department, and the Fiscal Affairs Department The analysis in this report has been coordinated in the Research Department under the general direction... primarily of the staff of the World Economic Studies division, ably led by Charles Collyns and, since January, Subir Lall I would also like to recognize the particular contribution of Tim Callen, who led this division for three years and who helped shape this issue of the World Economic Outlook during its design and development In addition, I must emphasize, as always, that other IMF staff, both within the. .. Subramanian, Kang Yong Tan, and Shang-Jin Wei Linda Griffin Kean of the External Relations Department edited the manuscript and coordinated the production of the publication The analysis has benefited from comments and suggestions by staff from other IMF departments, as well as by Executive Directors following their discussion of the report on March 19 and 21, 2 008 However, both projections and policy considerations... volatility, and should be equitable so as not to put undue burdens on the countries least able to bear them CHAPTER 1 GLOBAL PROSPECTS AND POLICIES The global expansion is losing speed in the face of a major financial crisis The slowdown has been greatest in the advanced economies, particularly in the United States, where the housing market correction continues to exacerbate financial stress The emerging and. .. reflection of increasing downside risks to the growth outlook over this period Most dramatically, the Federal Reserve has lowered the federal funds rate by 300 basis points since August 2007, while the Bank of Canada and the Bank of England have also reduced policy rates and the ECB and the Bank of Japan have forgone further interest rate increases In the United Kingdom, the authorities also provided a full... Nevertheless, the U.S dollar is still judged to be somewhat on the strong side Given the limited upward flexibility in the currencies of a number of countries that have large current account surpluses—notably China and oil-exporting countries in the Middle East the main counterpart of the decline in the U.S dollar has been appreciation of the euro, the yen, and other floating currencies such as the Canadian... amplifying credit cycles is at the heart of the financial accelerator mechanism modeled by Bernanke, Gertler, and Gilchrist (1999) and is the focus of the models of Kiyotaki and Moore (1997), Suarez and Sussman (1997), Cordoba and Ripoll (2004), and Matsuyama (2007) FINANCIAL MARKET TURBULENCE: ROCKY RIDE FOR THE ADVANCED ECONOMIES duration.4 In the extreme, even a temporary failure by the banking system to . World Economic Outlook, April 2 008 World Economic Outlook Housing and the Business Cycle World Economic Outlook Housing and the Business Cycle World Economic and Financial Surveys INTERNATIONAL. Surveys INTERNATIONAL MONETARY FUND 08 APR IMF APR 08 WORLD ECONOMIC OUTLOOK April 2 008 Housing and the Business Cycle International Monetary Fund World Economic and Financial Surveys ©2 008 International Monetary. The Changing Housing Cycle and the Implications for Monetary Policy 103 Developments in Housing Finance 104 The Housing Sector and the Business Cycle 107 Housing Finance and Spillovers from Housing