Page last updated at 12:45 GMT, Monday, 7 September 2009 13:45 UK

After the shock, challenges remain

By Stephanie Flanders
Economics editor, BBC News

Question: what's the difference between a recession and a depression? Answer: in a depression, policy doesn't work.

Officials at the London G20 finance ministers meeting

Just six months ago it seemed quite possible that we were going to find that out the hard way. We still might. But by common agreement, the risk of a global slump on a par with the 1930s has fallen substantially since the start of the year.

The extraordinary policy steps taken by governments and central banks since the Great Panic of September 2008 - the bank bail-outs, the record interest rate cuts, the trillions of dollars in budget stimulus - all of that seems to have worked. At least for now.

But today governments have to work out when - and how - to clean up the mess that those emergency measures have left behind. That could be even more challenging than the crisis itself.

Growth returns

A quick recap of the good news. There was growth between April and June. Maybe not in the UK or the US, the countries at the centre of the financial maelstrom, but France, Germany and Japan all supposedly grew in the second quarter of 2009.

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At the same time, the emerging economies - China, especially - have bounced back to rapid levels of growth, far quicker than anyone expected at the start of the year.

The OECD's latest estimate is for the G7 economies (USA, UK, France, Germany, Canada, Italy and Japan) to shrink by 3.7% in 2009. Back in June it thought the decline would be 4.1%.

Make no mistake: that would still make 2009 a pretty diabolical year. As the G20 finance ministers observed last weekend in London, the poorest countries will get the worst of it, and they are reliant on that quarrelsome bunch of politicians for their "automatic stabilisers", in the form of a better resourced World Bank and IMF.

At their meeting, the ministers confirmed that the pledge drive was nearly over almost all of the extra $850bn (£518bn) for the international financial institutions that was agreed by the G20 heads in April has now been pledged by individual countries.

It will be a while before the Fund and the World Bank actually get the money and even longer before it gets to individual countries.

But, now we are all in Lehman's anniversary mode, considering the events of the past year, things could surely be looking much worse. The US economy may well have started to grow in the last few months and even the UK will surely not be too far behind.

Remaining challenges

So what is now keeping those finance ministers awake at night? The answer is quite a lot. How and when to start unwinding all of that policy stimulus is the one we hear about most often, but there are two other big ones, much discussed in the corridors at that recent G20 meeting.

The first is still the state of the banks. Even though some big international banks are returning to profit earlier than expected, IMF figures on total unrealised losses on bank balance sheets as a result of the crisis suggest that there is room for plenty more bad news.

There are particular fears about Continental Europe (notably France and Germany). Officials fear that French and German banks have been allowed to remain in denial about a large chunk of their bad assets. Ministers there live in dread of new requests for expensive help.

Even where governments have engaged in extensive stress-testing to ensure that banks have enough capital to survive (as in the US and the UK), the big worry is that they still have too much debt - and too little capital - to want to lend.

More saving

The second big worry is that not enough is being done to lay the foundations for more balanced global growth. Personal saving in the US is now about 5% of gross domestic product (GDP) - up from roughly zero last year.

To get its house in order, the US needs saving to remain at least that high, so the US can stop building up mountains of foreign debt.

That is only consistent with rapid global growth if other countries step up to the plate, and promote domestic demand in their own countries as an alternative to exporting to the US. In Germany, one of the big surplus countries, ministers have expressly rejected this course.

In China, by contrast, officials insist they are planning to focus more on domestically generated demand, but right now it is difficult to predict how and when that commitment will bear fruit.

If there is no rebalancing of growth in favour of domestic demand in "saver" economies such as China and Germany, there will almost certainly not be enough growth. It is as simple as that. Unemployment will remain high across the developed economies, and public debt ratios will continue to rise, even several years into economic recovery.

The problem is easy to grasp. The solution is anything but.

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