US heading for sharp downturn: IMF

2 Oct, 2008, 2201 hrs IST, REUTERS
WASHINGTON: The United States will likely suffer a sharp economic downturn, or even recession, judging by the impact of similar banking crises around the globe over the past 30 years, the International Monetary Fund said on Thursday.

In new research, the IMF said the risk of recession is higher when financial turmoil is preceded by rising house prices and rapid expansion of credit, which was the case in the United States.

"The patterns of asset prices, aggregate credit and house borrowing in the United States during the current episode of financial stress appear similar to those of previous episodes that were followed by recessions," IMF research found.
After several years of a housing boom, the US economy has been shaken by a banking crisis that began with a spike in defaults among the riskiest mortgages and spread to Wall Street, marking the worst financial crisis since the Great Depression.

"It is now all too clear we are seeing the most dangerous shock to mature financial markets since the 1930s, posing a major threat to global growth," Charles Collyns, deputy director in the IMF's research department, told reporters.
The research, published in chapters of the IMF's bi-annual World Economic Outlook report, were compiled from 113 periods of financial stress in 17 advanced economies over 30 years.

The IMF compared the US turmoil to six banking-related crises that affected Finland, Norway, Sweden, Britain and the United States in the early 1990s, and Japan throughout that decade.

Half of these crises involved the banking sector and the remainder were in securities or foreign exchange markets.
Based on this metric, the current episode of financial stress ranks as one of the most intense for the United States and one of the most wide spread affecting virtually all countries in the sample," the IMF said.
It said, however, not all financial crises led to economic slowdowns or recessions, which occurred in half of the cases studied.
It said when a slowdown or recession follows a period of financial stress, and especially when the stress is in the banking sector, typically it is more severe, the IMF said.

In particular, slowdowns or recessions preceded by bank-related stress tend to involve two to three times greater cumulative output losses and tend to last two to four times as long, the IMF added.
Restoring banks' capital bases is critical to alleviate economic downturns, the IMF said.

"To limit the fallout on the real economy it is therefore of paramount importance that the damage to the banking systems in the United States and Europe is swiftly contained by far-reaching and comprehensive measures," Collyns added.

SLOWDOWN OR RECESSION?

What determines whether a banking crisis will lead to economic downturn or recession?

The fund said that depends on how much house prices and credit had risen before the onset of the crisis.

"While greater reliance on borrowing by non-financial corporations is associated with a sharper downturn in the aftermath of financial stress, the size of financial imbalances in the household sector is crucial in determining whether the downturn will turn into a recession," it said.

Still, the IMF said the severity of the downturn could be cushioned by such factors as the strength of corporate balance sheets when the crisis began and the aggressive monetary easing by the US Federal Reserve.

In the euro area, the relatively strong balance sheets of households offer some protection against a sharp down turn.

via:E.T