The World Economy

World GDP is expected to record a decline of 1.5 per cent this year, the first global decline in annual output since 1946. While this marks the deepest global recession since the Second World War, there are now signs that the crisis in the global banking system has eased. Supported by policy initiatives in economies throughout the world, there has been significant progress in restoring solvency to the global financial system, and lending conditions have started to improve modestly in many countries. While this has minimal impact on the prospects for growth this year, we see the recovery setting in earlier than expected three months ago as a result of the recent decline in global risk premia, with growth returning to most countries by early 2010. The recovery may be somewhat slower in countries such as Spain and Ireland, where housing market corrections will continue to weigh on the economy, while we expect a relatively rapid rebound in many Asian economies as rates of destocking decline and, as a result, world trade recovers from the recent slump. However, the financial crisis will leave permanent scars in most major economies, as lenders are expected to require higher risk premia than the low levels seen from 2003–7, so that the level of potential output will be permanently lower than forecast before the crisis. The magnitude of scarring will vary across countries, depending on the extent to which lenders underestimated risk before the crisis.