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Global Slowdown Places Even More Emphasis on Fiscal Stimulus

I think most Americans have the sense that we’re stumbling through the fourth year of a financial crisis with a low-growth recovery. What is less appreciated is the way in which America is actually performing the best among almost all nations at this point. We’re mired in a global slowdown, one with knock-on effects for America, but one where the rest of the world actually lags behind America. And America could easily revert to the mean here, if they follow the European prescription of poison for the sick patient by undergoing austerity measures. The way in which policymakers navigate the fiscal slope becomes crucial here.

Plagued by uncertainty and fresh setbacks, the world economy has weakened further and will grow more slowly over the next year, the International Monetary Fund says in its latest forecast.

Advanced economies are risking recession, the international lending organization said in a quarterly update of its World Economic Outlook, and the malaise is spreading to more dynamic emerging economies such as China.

The IMF forecasts that the world economy will expand 3.3 percent this year, down from the estimate of 3.5 percent growth it issued in July. Its forecast for growth in 2013 is 3.6 percent, down from 3.9 percent three months ago and 4.1 percent in April.

Underpinning that bleaker scenario are the assumptions that Europe will continue to ease monetary policy and that the U.S. will avert a crushing blow to growth by fending off a so-called “fiscal cliff” that could result from a failure to reach a compromise on its budget law and tax cuts.

The Organization for Economic Cooperation and Development sees the same global slowdown on the horizon.

And what the IMF says here is that the global economy would sink even more if we retrench on fiscal policy. And we’re already planning to do some of that. Jan Hatzius of Goldman Sachs cannot figure out why nobody wants to extend the payroll tax cut, which if allowed to expire will dampen GDP growth by close to 1%. I explained why I think it will happen – the relationship with the Social Security trust fund ultimately robbed it of its champion. So the country will experience this fiscal drag on growth. And that will happen amid a global slowdown that will reduce world demand for US exports. And I don’t even want to talk about the debt limit, which is fast approaching.

Meanwhile, IMF chief economist Olivier Blanchard explained today that the “fiscal multiplier,” the economic impact of fiscal policy, is actually higher than previously thought. This provides even more impetus not to take away stimulative fiscal policies amid a global slowdown, as fiscal austerity bites more and fiscal stimulus helps more than earlier expectations.

And the IMF is urging that countries who have ‘room to maneuvre’ such as the UK, France and the Netherlands, should “smooth their planned adjustment over 2013 and beyond” if growth falls significantly below the IMF’s increasingly gloomy forecasts.

In other words, it’s time to start borrowing to spark a recovery.

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David Dayen

David Dayen