Is it fair to compare the recent plunge in stock markets with the early stages of the crisis in 2008 and are we heading towards a double-dip recession? These and other frequently asked questions on the current economic turmoil are addressed by UN DESA’s Development Policy and Analysis Division (DPAD).

Q1: Many observers draw a parallel between the recent plunge in stock markets and the early stage of the global financial crisis in 2008. Is that a fair comparison?

To some extent it is. The precipitous sell-off in global stock markets, the heightened market volatility, growing fears for a spreading sovereign debt crisis in Europe and escalating risks of a double-dip recession all have elements of resemblance to the situation in the first half of 2008, just before the global financial crisis erupted.

In some respects, the current situation may be even worse. In 2008, the main concern was with stress in the private financial sector. Now facing both public debt distress and continued financial sector fragility and the two are interwoven. In late 2008, many governments were able to mobilize large-scale resources to combat the crisis. Now most developed countries face greater fiscal constraints and political resistance to more government intervention.

In other respects, things are better now. Banks have disposed of a large proportion of toxic assets and have increased their capital. Households and firms have also managed to scale back their debts.

Q2. Are we heading towards a double-dip recession?

This may well be true for the advanced economies. Unemployment rates remain high and are a drag on the recovery of output. The economy of the euro zone has come to a virtual standstill already with growth in France and Germany faltering and the debt-ridden economies of Greece and Portugal have never been out of recession over the past three years. Economic growth in the United States has also decelerated significantly in the first half of the year, to less than 1 per cent, while Japan had already entered in another recession by the end of 2010.

The global economy need not enter into a double-dip recession, however, as growth in developing countries is still strong. Even so, their economic expansion is also slowing, in part because of the weakness in the advanced economies.

Q3: Is fiscal austerity the answer?

As such, it is not. The high unemployment and lack of private consumer and investment demand in advanced economies would in fact call for some additional fiscal stimulus. True, this may add to government debt, but so would a sliding economy that eats into government revenue and pushes up debt ratios.

For most advanced economies, the focus should be on measures stimulating jobs growth more directly in the short run and lay out credible plans for reducing budget deficits and debts over the medium run once economies are going again. Not all economies are in a position to do so, especially where the debt situation is beyond limits, such as in Greece and Portugal. Their plans for fiscal sustainability have greater urgency, but can only be effective with further external financial support and stronger growth in the euro zone because else an even deeper recession would defeat attempts at fiscal consolidation.

In short, national policies need to be coordinated internationally. During the financial turmoil of the past weeks, investors have been mostly concerned with faltering economic activity, not with fears for debt defaults per se.

Q4. Will the US dollar weaken following the downgrading of the credit rating for US sovereign debt?

The downgrading has exacerbated uncertainty in foreign exchange markets. So far, however, investors do not seem to have given up hope in the dollar and also their confidence that the United States will honour its debt obligations seems unscathed. In fact, over the past weeks they have bought more US Treasury bills as a sign these are still a ‘safe haven’ amidst all uncertainty and interest rates have fallen.

What happens next remains to be seen. No doubt we will see continued exchange rate volatility among major currencies in the short run. Over time, the tendency of the US dollar to fall is likely to resume if its external deficit persists.

Q5. What will happen to growth and poverty in the developing countries?

For now, growth rates are still up in developing countries and also employment has returned (on average) to pre-crisis levels. The slowdown in Europe and the United States will hurt their exports. Further declines in commodity prices will be a mixed blessing: some economies will see inflationary pressures ease with lower food and energy prices; others, depending on commodity exports, will see bleaker growth prospects. The uncertainty and related volatility in commodity prices and capital flows will be damaging to all, however, as it will affect long-term investment decisions and complicate macroeconomic policies.

Many developing countries showed resilience during the global crisis, but fiscal space is running out for a number of them to counteract another major drop in external demand. Many countries have already shifted to more restrictive policies in order to counteract high domestic inflation. But poverty reduction will be better served by a stable external environment and by policies focusing on making economic growth more inclusive through agricultural development, industrial diversification, and social development programmes.

For more information:

UN DESA’s Development Policy and Analysis Division (DPAD):

http://www.un.org/en/development/desa/policy/index.shtml

To stay updated, please follow the analysis in the Monthly Briefings on the World Economic Situation and Prospects: http://www.un.org/en/development/desa/policy/wesp/wesp_mb.shtml