IMF: World Headed for 'Global Recession'

Oct. 8, 2008 — -- Damage from the financial meltdown is expected to push the United States into a deepening recession, and the wider effect will be a sharp slowdown of the global economy, according to a report by the International Monetary Fund released today.

The IMF's World Economic Outlook sharply revised preductions for growth in the global economy and painted a darker portrait of prospects for the financial health of the United States, according to The Associated Press, which reviewed the report.

"The world economy is now entering a major downturn in the face of the most dangerous shock in mature financial markets since the 1930s," the IMF said in its report, according to the AP.

The report projects that the global economy will slow from a growth rate of 5 percent last year to 3.9 percent this year and 3 percent next year, which would be the lowest level since 2002, according to the AP.

A global growth rate of the 3 percent or less is considered by the IMF to be a wordwide recession.

The report came as the Federal Reserve, along with the Bank of Canada, the Bank of England, the European Central Bank, Sweden's central bank and the Swiss National Bank came together to cut interest rates.

The Fed dropped its key federal funds rate from 2 percent to 1.5 percent. Fed chairman Ben Bernanke as much as telegraphed this cut could happen -- though perhaps not this soon -- Tuesday when he spoke in Washington and said U.S. "economic growth has worsened."

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Overnight before the announcement, Tokyo's Nikkei closed down 9.4 percent -- its biggest drop in 21 years. European markets initially opened down and then retreated again into negative territory. U.S. markets initially benefited from the cut and then also retreated. By noon, the Dow was down roughly 200 points. Then just an hour later, it returned to positive territory.

The half point cut announced by the Federal Reserve is the largest intra-meeting rate cut since the big .75 percent cut Jan. 21. Cutting rates between scheduled meetings is rare, so today's action can be seen as exceptional and an acknowledgement that the economy is in trouble. China's central bank also announced a rate cut today.

Investors and market analysts around the globe have talked about the need for greater coordination among central banks to combat what has now become a global economic slowdown.

Kenneth S. Rogoff, an economics professor at Harvard University and a former economist at both the International Monetary Fund and the Federal Reserve, called the cut "a positive development."

"It's just a no-brainer that the central banks needed to try cutting interest rates with the wholesale panic going on," he said.

Rogoff said that the banks have, up until now, tried to draw a distinction between its monetary rate-setting policy and being the lender of last resort.

"But the panic is so overwhelming at this point that they really need to fire on all fronts," Rogoff said, adding that the 0.5-percent, or 50 basis point cut, "should have been more aggressive."

"They think 50 basis points in aggressive. But in this environment it's not," Rogoff said. "It should have been 100."

Many economists have been calling for this kind of coordinated central bank action as the effects of the U.S. market meltdown have spread around the world.

The United States, Spain and Australia took action Tuesday in advance of the intrest rate cuts.

The Federal Reserve announced that it was starting an ambitious program to buy up to $99 billion worth of unsecured short-term debt, using a little-known federal instrument that dates to the Great Depression of the 1930s.

The so-called commercial paper market is the method many businesses rely on to fund day-to-day operations.

The Fed announced in a statement that the creation of the Commercial Paper Funding Facility, which will complement the Federal Reserve's existing credit methods of providing liquidity to term-funding markets.

In Madrid, Prime Minister Jose Luis Rodriguez Zapatero announced Tuesday that Spain is setting aside up to $41 billion to help the financial sector, and said the government would also increase the deposit insurance for citizens to $136 billion per account, a twofold increase.

Australia took action too, announcing it was lowering its key interest rate from 7 percent to 6 percent, the biggest reduction in more than seven years.

In a statement announcing the cut, the governor of the Reserve Bank of Australia attributed the bank's decision in part to the "the recent deterioration in prospects for global growth, together with much more difficult market conditions even for credit-worthy borrowers."

The United States has already taken an aggressive approach on the interest rate front, with the Federal Reserve and its Chairman Ben Bernanke cutting its key interest rate from 5.25 percent in September 2007 to 1.5 percent today.

Lower rates are generally a stimulus for the economy because they make the cost of capital cheaper, encouraging businesses to expand and invest. However, in the current financial crisis, interest rates have not been the issue -- no one is willing to lend due to a lack of confidence that they will be repaid.

The Fed and European Central Bank worked together to cut rates after the Sept. 11, 2001, terrorist attacks. Such acts are highly unusual, and today's move is unprecedented.

England and the European Central Bank were both expected to make cuts but other countries were seen as a bit more reluctant.

The Bank of Japan already has its key interest rate at 0.5 percent. The central bank confirmed yesterday, as expected, that it would leave the interest rate unchanged. Given that country's 2 percent inflation rate, the rate is essentiality negative.

David R. Kotok, co-founder and chief investment officer of Cumberland Advisors, said Monday night that such cooperation "will send some psychological message."

"It really is not needed," Kotok wrote in an e-mail. But "each of them will cut anyway, so we will see serial cuts in close proximity."

Mike Ryan, head of wealth management research at Americas at UBS, said that the United States and other countries have so far taken a "parochial approach" to addressing the financial crisis by addressing it on a "local level."

"The approach is almost exclusively done on a country by country, event by event basis," he said.

Ryan said that, instead, the G8 countries should be working together to address the financial crisis with a "global approach."

That should include but not be limited to a coordinated effort to cut rates by the different central banks, he said, including the European Central Bank, which had -- before today -- yet to cut rates recently because of inflation concerns.

"We are hopeful that what we'll start to see is some measures put in place that will send some signals that global policymakers are going to work in tandem," Ryan said Monday.

Gerald P. O'Driscoll Jr., a former vice president of the Federal Reserve Bank of Dallas and Citigroup, also questioned the need by some countries to make a cut.

"What are the Japanese going to do? I guess they can go back to zero, which they are very reluctant to do," O'Driscoll said. "The Europeans have the most scope for cutting."

While the U.S. Federal Reserve had its main rate at 2 percent, O'Driscoll said in recent days the Fed has put so much cash into the banking system that it has essentially already pushed rates lower in the marketplace.

"It would just be acknowledging what they have already done," he said. "Then, what happens if it doesn't work?"

"Then he's stuck," O'Driscoll added. "Then everybody knows the next thing he has to do is pull a Japan and go to zero."

A rate cut is probably not going to calm the markets, he believes. The problem is that many firms are deemed risky because they borrowed too much money to finance their investments. The only cure for that is to de-leverage those investments.

"It's ugly, but it's not susceptible directly to central bank action," O'Driscoll said. "Would it do a great deal of harm? Probably not. Would it do a great deal of good? Probably not, unless it turned out to be the magic bullet that restored confidence, and so far, nothing that either central banks or governments have been doing is restoring confidence.

"Maybe because part of it, that they just keep switching plans and coming up with new plans. After you do that several times, and I'm especially thinking of [Treasury Secretary Henry] Paulson, less maybe the Fed, people begin to say, 'Does this person know what they are doing? Or do they have a plan?'"

With reports by ABC News' Alice Gomstyn, Daniel Arnall and The Associated Press.