VoxEU Column Global crisis Monetary Policy

Why is this global recovery different?

The Great Recession has been followed by a ‘Not-So-Great Recovery’. Why the recovery has been weak and protracted remains a matter of debate. This column argues that one specific aspect of the current global recovery makes it different from previous ones. Over the course of past recoveries, both monetary and fiscal policies maintained an accommodative stance. In this global recovery, fiscal and monetary policies in advanced economies are pushing in opposite directions.

There is an intensive discussion about the weak and protracted nature of the ongoing recovery.

  • Some argue that this is not surprising since recessions associated with financial crises are often followed by sluggish recoveries (Reinhart and Rogoff 2012).
  • Others claim that policy uncertainty has been a major impediment to growth in the US (Baker et al. 2012).
  • Yet others emphasise additional elements, including problems in the design of the Eurozone and the highly synchronised nature of the 2009 recession (Bems, Johnson, and Yi 2009; Weil 2012; Reichlin et al. 2013).

In the latest World Economic Outlook, we analyse the evolution of fiscal and monetary policies during the ongoing global recovery and show that they have been following rather distinct trajectories compared with those during the previous episodes. We argue that, along with other factors as highlighted in the literature, it is important to consider the role of policies in determining the growth outcomes during recoveries.

Understanding global recessions and recoveries

The world has experienced four global recessions over the past 50 years - 1975, 1982, 1991, and 2009. A global recession is a decline in world GDP per capita accompanied by a broad decline in other indicators of the global economic activity such as industrial production and employment (see Kose et al. 2013b). These global recessions were followed by global recoveries, whereby economic activity rebounded generally accompanied by a synchronised pickup in worldwide consumption, investment and trade.

Divergence of activity

At first blush, the current global recovery is following a path strikingly similar to the average of the three past recoveries (Figure 1). The world economy has been able to return to the pre-recession level of world output within a year.

Figure 1 Real GDP per capita (index, PPP weighted)

Notes: Dashed lines denote WEO forecasts. Indexed to 100 in the year before global recession.Zero is the time of the global recession year. Each line show the PPP-weighted average of the countries in the sample.

But this masks a sharp divergence of activity across advanced and emerging market economies (Figure 2). This recovery has been the weakest for advanced economies and the strongest for emerging markets. The IMF’s forecasts suggest that this divergence will persist in the near term.

Figure 2 Real GDP per capita: Advanced countries and emerging markets (index, PPP weighted)

Notes: Dashed lines denote WEO forecasts. Indexed to 100 in the year before global recession. Zero is the time of the global recession year. Each line show the PPP-weighted average of the countries in the respective group.

Divergence of policies

What accounts for this divergence in fortunes? As we noted above, there are several factors that could explain this, including the severity of the financial crisis, problems in the design of the Eurozone, the highly synchronised nature of this recession, uncertainty associated with policies, and so on. Another factor at play could be the substantially different paths of fiscal and monetary policies in advanced economies. In particular, whereas the directions of fiscal and monetary policies were aligned in previous episodes, during the current recovery these policies have marched in opposite directions.

The current and projected paths of government expenditures in the advanced economies are quite different than during past recoveries (Figure 3). During the past recoveries, fiscal policy was decisively expansionary, with increases in real primary government expenditures. This time is different. It is true that in some advanced economies, especially in the US, the fiscal stimulus introduced at the outset of the Great Recession was far larger than during earlier recessions. However, the stimulus was unwound early in the ensuing recovery. Specifically, expenditures fell during the first two years of this global recovery and are projected to continue to decline modestly in the coming years. This pattern also holds across the major advanced economies, with the Eurozone and the UK showing sharp departures from the typical paths of government expenditures in the past.

Figure 3 Real primary expenditure (index, PPP weighted)

Notes: Dashed lines denote WEO forecasts. Indexed to 100 in the year before global recession. Zero is the time of the global recession year. Each line show the PPP-weighted average of the countries in the respective group.

In contrast, in the emerging market economies the ongoing recovery has been accompanied by a more expansionary fiscal policy stance than during past episodes. This was possible because these economies had stronger fiscal positions this time around than in the past.

Monetary policies in the advanced economies have been exceptionally accommodative during the latest recovery compared with earlier episodes (Figure 4). Policy rates have been reduced to record-low levels and central bank balance sheets in the major advanced economies have been dramatically expanded compared with earlier episodes. Monetary policy in emerging market economies has also been more supportive of economic activity than in the past.

Figure 4 Short-term interest rate during global recessions and recoveries (percent)

Notes: Aggregates are market weighted by GDP in US dollars; observations are dropped for countries experiencing inflation 50 percent greater than in the previous year. Policy rate used as the principle series. Three-or four-month treasury bill data used as a proxy if data series was longer. Zero is the time of the global recession year. 

What explains the divergence of policies?

Caution about fiscal stimulus and the pace of consolidation in this recession and recovery are likely explained by high ratios of public debt to GDP and large deficits (Figure 5). Advanced economies entered the Great Recession with much higher levels of debt than in past recessions. These high debt levels reflect a combination of factors including expansionary fiscal policies in the run-up to the recession, financial sector support measures, and substantial revenue losses resulting from the severity of the Great Recession. The deficit levels in some advanced economies are currently large in part because of the collapse in revenues.

Figure 5 Public-debt-to-GDP ratios during global recessions and recoveries (percent of real GDP of year before global recession)

Notes: Aggregates are market weighted by GDP in US dollars. Dashed lines denote WEO forecasts. Zero is the time of the global recession year.

Moreover, sovereign debt crises in some Eurozone periphery countries and challenges associated with market access put pressure on these economies to accelerate their fiscal consolidation plans. At the same time, there was more room for monetary policy manoeuvring because inflation rates were much lower at the beginning of the recession than in the past.

What policy mix?

The evidence presented here does not in itself permit an assessment of whether the different policy mix in this recession and recovery was appropriate. The response of policies may have been reasonable given the respective room available for fiscal and monetary policies in advanced economies.

However, there are also concerns. Even though monetary policy has been effective, policymakers had to resort to unconventional measures and even with these measures, the zero bound on interest rates and the extent of financial disruption during the crisis have lowered the traction of monetary policy (Werning 2012; Krishnamurthy and Vissing-Jorgensen 2011; D’Amico et al. 2012; Swanson and Williams 2013). This, together with the extent of slack in these economies, may have amplified the impact of contractionary fiscal policies (Blanchard and Leigh 2013; Christiano, Eichenbaum and Rebelo 2011; Auerbach and Gorodnichenko 2012).

Four years into a weak recovery, policymakers may need to worry about the risk of overburdening monetary policy as it is now being relied upon to deliver far more than it has ever needed to in the past.

Authors’ note: The views expressed here are those of the authors and do not necessarily represent those of the institutions with which they are affiliated.


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