Caution remains the watchword for economic policy-makers and central bankers who are patting themselves for the unprecedented levels of globally-coordinated aggressive monetary and fiscal measures taken which helped prevent a “total collapse” of the international financial system and a “free fall” for advanced economies. The financial breakdown in September 2008 led to the global downturn which could have been “extraordinarily deep and protracted but for the actions taken”, according to US Federal Reserve Chairman Ben Bernanke.

There are still serious risks and uncertainties down the road, they all agree, and it would be A weak recovery for the global economy into 2010 even if sustained largely by Asian emerging economies which are going through a rebound in varying degrees. After the sharp contraction of the past year, Fed notes, economic activity appears to be levelling out both in United States and abroad. But growth recovery would not be strong to reduce unemployment (9.4 per cent in USA at present and expected to rise to 10 per cent by 2010).

The International Monetary Fund (IMF) is even more cautious than governments and central banks. Its July estimates of growth decline in 2009 (-2.6 per cent) and reversal (1.7 per cent) in 2010 may get updated ahead of the annual Fund-Bank meetings October 6-7). More importantly, IMF envisages a fundamentally changing scenario resulting from the most severe financial crisis since the Great Depression.

President Obama, going through a more challenging phase of his Presidency with the health care reform controversy and troubles in Afghanistan, has re-nominated Mr Ben Bernanke for a second four-year term as Chairman of US Federal Reserve (central bank) with praise for the latter's calm and creativity and bold actions that helped 'to put brakes on our economic free fall'.

Taking into account the enormous costs of the crisis to fiscal systems for recession-hit developed nations with their public debt ratios touching highest levels in decades, IMF sees an inevitable “structural shifts” in demand and consumption from advanced to emerging economies. Developing economies would be main drivers of growth implying a rebalancing of demand as between developed nations and emerging and other developing economies.

IMF Chief Economist, Mr Olivier Blanchard, says there would be no return to normal growth, as the present crisis has left “deep scars” which would affect both supply and demand for many years to come. Also, the ruined financial systems of developed countries would take time to find “new shape” and meanwhile their resource allocation role would remain impaired.

In effect, the crisis is generating a reshaping of the global economic framework which, it is hoped, would lead to a substantial reduction of the present global imbalances (between surplus and deficit countries), a well-regulated banking system with strict supervision over systemically important institutions operating across the world, and an effective role for developing countries in the management of world economy. There would thus have to be a virtual re-writing of the rules of globalisation based on free market capitalism.

The costs of the crisis have added to fiscal burdens for all countries making higher taxation in many cases inevitable, according to IMF. US fiscal deficits and debt ratios, already huge, are on an unsustainable path. Solid growth needed to narrow fiscal imbalances depends on revival of consumer spending which accounts for 70 per cent of the U S economy. Retail spending would remain depressed for a long time as US consumers, in the midst of recession and job losses, are now tending to save, giving up their hitherto free spending style. The ratio of household savings to disposable incomes, which was near zero in 2007, has now risen to 5 per cent and would probably go up and not down.

Leading economists aver that US will not be in a position to become the principal engine of growth for some years though it would be central to any world recovery. This is mainly due to the damaged financial system, rising unemployment, weak housing market, falling household consumption and glut of unutilised capacity, inventories having been drawn down. In other words, the world economy can no longer rely on US consumption binge from Americans overburdened by housing and credit card debts and having lost trillions of dollars in home and stock values.

Secondly, IMF economists add, the post-crisis performance everywhere would be below potential and early return to high growth rates (such as India pines for) is ruled out. As the United States, the world's largest economy, with its damaged financial system and long-run deficits and debt on the horizon, is incapable of resuming its locomotive role, IMF sees the world economy needs a “rebalancing” involving (a) move from public to private spending, and (b) shift from the domestic to foreign demand in USA (with rising net exports) and reverse shift from foreign to domestic demand in the rest of the world, particularly in Asia.

For sustained recovery in the United States, IMF points out, there would have to be increase in net exports and decrease in its current account deficits while the rest of the world would have to reduce their current account surplus. A decrease in China's current surpluses, in particular, would help increase demand and sustain US recovery, which in turn would result in more US imports to sustain world recovery. Other Asian countries with current account surplus could decrease saving and allow their currencies to appreciate and that would lead to shift from external to internal demand and reduction in their trade surpluses.

Central Bankers of major countries at their annual meeting in Jackson Hole (Wyoming-USA), addressed by Mr. Ben Bernanke and M. Jean-Claude Trichet, European Central Bank President, noted signs of recession tapering but agreed that difficult challenges still lay ahead and policy-makers in the world should not forget the lessons of the financial crisis. They are in no hurry to reverse the accommodative monetary stance aggressively pursued so far.

The Fed has already decided it would continue to maintain its targeted federal funds rate at zero to 0.25 per cent for an extended period, despite signs of improvement, in view of ongoing job losses, sluggish income growth, housing wealth at low levels and tight credit. In Fed's view, despite some rise in prices of energy and other commodities, inflation would remain subdued for some time.

In the perspective of the Third G-20 Summit in Pittsburgh (September 25-26), Mr. Bernanke said the structural weaknesses in the financial system must be urgently addressed. Decisions are likely to emerge from the Pittsburgh Summit on the broad elements of the overhaul of the global financial system. G-20 Finance Ministers are meeting in London on September 4-5.

The United States' proposals before the Congress assign an expanded role for the Federal Reserve to supervise systemically important institutions including insurance companies and other financial institutions which are not banks. The European Commission is yet to come out with its legislative proposals on regulations for the European financial system. (IPA Service)