IMF: global inter-connectedness aggravated recession

A paper published by the IMF this month, challenges the notion of the Great Moderation in light of the extreme volatility in output experienced globally during the financial crisis.

The paper finds the recent experience can be attributed to greater sensitivity to external shocks and increased international spillovers due to greater global integration as opposed to an increase in output volatility per se.

According to the report, the reduction in output volatility ceased in some advanced countries by the mid-1990s, and a mild tendency towards increased volatility was evident in some countries like Germany, which experienced an increase in output growth. The bottoming out of the decline in output volatility and its possible reversal was associated with an increased role for spillovers, starting sometime in the mid-1990s. According to the paper, it was not the size of the spillover shocks but rather the sensitivity of countries to these shocks that increased overtime.

The evidence is consistent with the idea that improved domestic policies and structural changes drove down the size of domestic shocks and hence aggregate volatility. However, potent though these forces were, the increased-interconnectedness nature of the global economy introduced countervailing tendencies.

As the global economy became more integrated, shocks from one country was transmitted more rapidly and to more countries as countries most reliant on global financial and trade link were the hardest hit during the crisis.

The report shows that imbalances in or shocks by one country have increasingly important implications for other countries means that greater transparency between countries is needed as all countries have a stake in the policy stance and approaches of other countries.

Click here to read paper