The WEO, published twice a year, analyzes and makes projections about global economic developments. These two analytical chapters, Chapter 3: "From Recession to Recovery: How Soon and How Strong?" and Chapter 4: "How Linkages Fuel the Fire: The Transmission of Financial Stress from Advanced to Emerging Economies," examine past business cycles and financial crises to help us better understand the current global recession and financial crisis. This Wednesday, the IMF will release Chapters 1 and 2 of the WEO, which contain its review of recent global economic trends and global economic forecasts.
After the release of Chapters 3 and 4, the financial media focused understandably on Chapter 3, which is of more direct and immediate interest to most people, especially in advanced economies, than Chapter 4. But Chapter 4 contains important lessons for emerging economies, which are suffering from the worst global crisis since the Great Depression. It shows that global financial integration can be a curse as well as a blessing for them. That's why I will focus on it in this column.
But first, here is a brief summary of Chapter 3, which explores the severity of the current global recession and the likelihood of recovery from it in comparison with past recessions and recoveries. It analyzes, based on the examination of business cycles since 1960 in 21 advanced economies, recession and recovery patterns and the role of macroeconomic policies in those patterns. Its major findings are: (1) A particularly virulent type of recession, like the current one, that is coupled with a financial crisis and is also globally synchronized -- rare among recessions -- is more severe than those that are not, and recovery from such a recession is both weaker and slower; (2) Expansionary macroeconomic policies -- fiscal policies more than monetary policies -- help in fighting recessions and accelerating recoveries; (3) Based on the first two findings, we should expect the current recession to be exceptionally long and severe and the recovery from it to be unusually slow; and (4) The prospects for recovery can be improved, however, by strong expansionary macroeconomic policies and the restoration of confidence and stability in the financial sector.
Chapter 4 tries to answer the following questions: (1) How severe is the current global financial crisis relative to past ones? (2) How did it spread from advanced to emerging economies? (3) Why did it hit some emerging economies harder than others? and (4) What are its implications for future capital flows from advanced to emerging economies? In order to answer these questions, IMF researchers use a new financial stress index (FSI) for emerging economies, adapted from a similar index that was constructed for advanced economies in last October's WEO. This new FSI measures the intensity of stress across different segments of the financial sector, i.e., equity markets, exchange markets and the banking sector, as an average of five components: the exchange market pressure index, sovereign bond spreads, the banking sector's stock market beta, stock returns and time-varying stock return volatility. When a country's FSI rises one-and-a-half standard deviations above its mean in a given period, it denotes a financial stress episode. The IMF will make the FSI series available, on a monthly basis since 1997, for 18 emerging economies, including Turkey, on its Web site after this week.
I will continue to cast a more detailed view on Chapter 4 of the WEO in my column tomorrow.
